Dollar slips as yen hits seven-month high on BOJ hike bets

The dollar fell on Tuesday, pressured by a sharp rally in the Japanese yen as investors ramped up bets on an imminent Bank of Japan interest rate hike and unwound bearish carry-trade positions ahead of key U.S. inflation data. 

The yen rose 0.2% to touch 154.00 per dollar in early trade - its strongest level since February - as currency desks continued to dismantle bearish carry-trade bets. The Dollar Index, which tracks the greenback against six major currencies, was down 0.3% at 98.81. 

Meanwhile, major European peers held relatively steady in quiet trade: the euro anchored near $1.1610 ahead of Thursday’s European Central Bank meeting, and the British pound held firm around $1.3520.

BOJ rate hike bets surge to 75% on upgraded GDP and capital repatriation

The primary driver behind the yen’s sustained charge is a fundamental re-calibration of Japan’s monetary trajectory, reinforced by robust domestic growth data and explicit government backing.

Japan’s gross domestic product was revised upward on Tuesday to show an annualized expansion of 1.4% in the April-June quarter, beating preliminary estimates of 1.1%. The economic resilience has given Bank of Japan Governor Kazuo Ueda clear fundamental backing to press ahead with policy normalization:

Futures now price in roughly a 75% probability that the BOJ will deliver a 25-basis-point rate hike at its Sept. 18 meeting, with money markets assigning a 60% chance to a follow-up increase before year-end.

Institutional allocators are pointing to accelerating capital repatriation back into domestic Japanese assets, supported by narrowing interest rate differentials against Western paper.

Japanese Finance Minister Satsuki Katayama reaffirmed on Tuesday that Tokyo’s currency stance remains aligned with Washington following joint intervention operations, confirming she stays in constant communication with U.S. Treasury Secretary Scott Bessent.

The backdrop comes as official data showed Japan’s foreign securities reserves plunged by a record $87.8 billion in August to fund currency support.

"In the longer run, however, we believe the shrinkage in the interest rate differential to date will promote the unwinding of JPY carry and the will take a clear downward turn," Citi analysts said.

Dollar under pressure as markets await CPI test

While the dollar index found brief support late last week following a blowout U.S. nonfarm payrolls report - which showed 162,000 jobs added in August - the greenback has struggled to maintain upward momentum as traders brace for crucial inflation data.

Money markets currently price in roughly a 60% probability of a 25-basis-point Federal Reserve rate hike at its Sept. 15-16 FOMC meeting.

However, fixed-income and FX desks are reluctant to expand dollar long exposure ahead of Friday’s U.S. Consumer Price Index (CPI) readout, which is viewed as the ultimate catalyst determining whether Fed Chair Kevin Warsh and policymakers resume monetary tightening.