Dollar Declines as Yen Surges Amid Fed Rate Cut Speculations

The dollar weakened and the yen reached its highest level in over a year as market expectations grew for a significant rate cut by the Federal Reserve. Investors are also watching the Bank of England and Bank of Japan's policy decisions this week. Futures markets anticipate varying degrees of Fed rate cuts.

The dollar weakened, while the yen soared to its highest level in more than a year on Monday. Market participants increased their expectations for an oversized rate cut by the Federal Reserve later this week. The dollar hit a low of 139.58 yen, falling from the 140.285 end-December level to amounts last seen in July 2023.

A busy week in finance sees the Fed's Sept. 17-18 meeting at its peak, expecting policy decisions from the Bank of England and Bank of Japan on Thursday and Friday, respectively. Previous Fed speakers and data releases have had markets debating whether the Fed will aggressively cut rates to counter labor market weakness or take a slower approach.

Futures markets are fully pricing in a quarter-point cut from the Fed on Wednesday, with a 60% chance of a larger 50 basis point move, a significant increase from last week's 15% probability. Niels Christensen, Nordea's chief analyst, remarked, 'It's all about the Fed and whether it will be a big 50 basis point cut or a smaller 25 basis one. That's why the dollar is softer across the board.'

The dollar index, which measures the currency against six peers, dropped 0.3% to 100.69. Treasury yields have been falling in anticipation of the Fed meeting, especially as the odds are stacking up for a half-point rate cut.

Benchmark 10-year yields have decreased by 30 basis points over about two weeks, while two-year yields, which are more closely linked to monetary policy expectations, were around 3.55%, down from approximately 3.94% two weeks ago. Chris Weston from Pepperstone noted that selling the dollar for yen has been the prime trade for investors looking to take advantage of the drop in Treasury yields.

Investors also have their eyes on the Bank of Japan's interest rate decision on Friday, expecting it to maintain its short-term policy rate target at 0.25% after raising rates twice this year.

Hopes for higher rates in Japan and lower rates in the U.S. have driven the yen higher. Nordea's Christensen added, 'We anticipate higher rates in Japan and lower rates in the U.S., making the interest rate differential favor a stronger yen against the dollar.'

Elsewhere, sterling rose 0.4% to $1.3170, and the euro climbed 0.4% to $1.1114 after the European Central Bank cut interest rates by 25 basis points last week. However, ECB President Christine Lagarde tamped down expectations for further reductions next month.

ECB's chief economist Philip R. Lane and Vice President Luis de Guindos are scheduled to speak on Monday. The Bank of England is projected to keep its key interest rate at 5% on Thursday, following its 25-basis point reduction in August.

Additionally, Bank of Canada Governor Tiff Macklem hinted at speeding up interest rate cuts, as reported by the Financial Times on Sunday. Having maintained its policy rate at a more than two-decade high of 5% for a year, the BoC has cut rates by a quarter point three times since June. The U.S. dollar remained relatively unchanged against the Canadian dollar at C$1.3579.

(With inputs from agencies.)