Central bank policy shift week! Yen and euro diverge, USD trend in the second half of the year awaits verification

Forex Market Weekly Review

Last week (12/8-12/12), market trends were clearly divergent. The US Dollar Index declined by 0.60%, while non-US currencies showed mixed performance. The euro surged 0.84%, the British pound rose 0.34%, the Australian dollar increased slightly by 0.18%, and the Japanese yen retreated 0.29%.

Federal Reserve Policy Shift: Can the Euro Maintain Its Strength?

Last week, EUR/USD rose by 0.84%, driven by a shift in Federal Reserve policy signals.

The Fed implemented a 25 basis point rate cut as expected, and announced the launch of the Reserve Management Purchase (RMP) program, purchasing $40 billion of short-term government bonds monthly. This move is seen as a prelude to quantitative easing (QE). Coupled with Chairman Powell’s relatively dovish stance, the US Dollar Index fell for two consecutive days.

It’s worth noting that the latest dot plot indicates only one rate cut is expected in 2026, but the market still broadly anticipates two rate cuts next year. This divergence could become a key variable influencing the dollar’s trend in the second half of the year.

【Image Source: CME FedWatch Tool】

Future direction of EUR/USD depends on two key factors: US November non-farm payroll data and the European Central Bank’s decision on December 18. The market expects the ECB to keep interest rates unchanged, with focus on whether President Lagarde adopts a dovish or hawkish tone, and the latest quarterly economic forecasts’ hints on monetary policy.

Morgan Stanley believes that amid ongoing divergence in US and European monetary policies, EUR/USD could surge to 1.23 in the first quarter of 2026.

This Week’s Focus

• ECB interest rate decision announced on December 18
• US November non-farm payroll data as a key catalyst
• If non-farm payrolls fall short of expectations, EUR/USD may rise further; otherwise, it could face downward pressure

Technical Outlook

EUR/USD has stabilized above the 100-day moving average, with RSI and MACD indicators both showing bullish momentum. The initial upside target is 1.18, with resistance at the previous high of 1.192. If prices pull back from higher levels, support is near the 100-day moving average at 1.164.

【Image Source: TradingView; EUR/USD trend】

Bank of Japan Rate Hike Approaching, Yen Outlook Uncertain

Last week, USD/JPY rose slightly by 0.29%, as markets digest the potential impact of Japan’s 2026 rate hike cycle.

On December 19, the Bank of Japan will announce its latest interest rate decision, widely expected to raise rates by 25 basis points to 0.75%, reaching a 30-year high.

【Image Source: Tradingeconomics; Japan interest rates over the past three years】

The rate hike expectation is already priced in, and market focus shifts to Governor Ueda’s comments on the pace of future hikes, especially his stance on the “neutral interest rate.”

Nomura Securities predicts that Ueda may keep his comments on the neutral rate vague to retain flexibility for policy adjustments. This decision is less likely to signal a more hawkish stance than market expectations.

U.S. banks suggest that if the BOJ adopts a “dovish rate hike” tone, USD/JPY could stay high or even approach 160 early next year. Conversely, if a “hawkish rate hike” signal is given, yen short covering could trigger a decline, with USD/JPY falling back toward 150. However, this scenario is less probable.

This Week’s Focus

• BOJ meeting on December 19
• US non-farm payroll data will influence yen exchange rate
• Any adjustments in US and Japan monetary policy expectations will directly impact USD/JPY direction

Technical Outlook

USD/JPY has broken below the 21-day moving average. Continued pressure below this level increases downside risk, with support around 153. If it reclaims the 21-day moving average, resistance is at 158.

【Image Source: TradingView; USD/JPY trend】

Outlook: H2 Dollar Movement Depends on Central Bank Policy Divergence

This week features a series of central bank decisions, and policy divergence is likely to further shape the dollar’s trend in the second half of the year. The interaction between ECB policy expectations, the BOJ’s hawkish stance, and the Fed’s rate cut outlook will be the main drivers in the forex market.