The Federal Reserve's decision is imminent, and extreme volatility in the foreign exchange market is inevitable!

Market Outlook Scan

Last week (December 1 to 5), the foreign exchange market showed a pattern of a weakening US dollar and gains across non-US currencies. The US dollar index declined by 0.50%, with the euro rising by 0.36%, the Japanese yen appreciating by 0.53%, the Australian dollar posting the largest gain of 1.36%, and the British pound also recording a 0.74% increase. The driving forces behind this trend warrant in-depth exploration.

Fed Rate Cut Expectations Rise, Can EUR/USD Rally?

Short-term Catalyst: Weakening Employment Data Paves the Way for Rate Cuts

EUR/USD closed up 0.36% last week, with rising market bets on a Fed rate cut being the main driver. US November ADP employment data underperformed, with non-farm payrolls dropping sharply by 32,000, marking the largest decline since March 2023. Meanwhile, the September PCE inflation index eased inflation concerns, all signaling a path toward a rate cut in December.

According to the latest data from the CME FedWatch Tool, the market’s probability of the Fed cutting interest rates by 25 bps on December 10 has reached 87.2%, with expectations even including two more rate cuts by 2026.

Next Week’s Market Focus: Dot Plot and Powell’s Remarks

The upcoming turning points will focus on the Fed’s dot plot, bond purchase adjustments, and Chair Powell’s language. If the December dot plot hints at more than two rate cuts by 2026, or if the Fed announces unexpectedly large bond purchase plans, the market will interpret this as dovish, further weakening the dollar and boosting EUR/USD upward momentum.

Conversely, if the dot plot indicates only one rate cut remaining in 2026 and Powell adopts a hawkish tone, the market will see this as a hawkish signal, supporting the dollar, while EUR/USD may face a correction.

Technical Perspective: Bullish Momentum Still Dominant

From a technical standpoint, EUR/USD has successfully broken above the 100-day moving average, with RSI continuing upward, indicating strong bullish momentum. If the rally persists, key resistance levels are at 1.18 and the previous high of 1.1918. However, if a pullback occurs from higher levels, traders should watch the 21-day moving average at 1.1593 and the previous low at 1.1491 for support.

Bank of Japan Rate Hike Expectations Surge, Can Yen Appreciation Accelerate?

Hike Expectations Strengthen but Exchange Rate Response Remains Mild

USD/JPY declined by 0.53% last week, driven mainly by rising expectations of a BOJ rate hike. According to Reuters, the Japanese government has indicated tolerance for the BOJ’s rate hike actions, and Governor Ueda has repeatedly signaled hawkish views. Market expectations for a rate hike in December have risen to about 90%.

Notably, despite the heightened expectations for a rate hike, the yen’s appreciation has been surprisingly mild. USD/JPY hovers around 155, with analysts suggesting this reflects a pessimistic view of the long-term real interest rate differential between Japan and the US—meaning even if Japan hikes rates, narrowing this gap will be difficult.

Long-term Struggle Between Inflation and Policy

Japan’s inflation outlook will continue under Prime Minister Fumio Kishida’s expansionary fiscal policies. Meanwhile, markets expect only one rate hike by the BOJ in 2026, implying limited room for narrowing the Japan-US interest rate differential. Divergences among institutions’ forecasts for USD/JPY forward levels also reflect this complexity: Mizuho Securities predicts a year-end level of 158, while Nomura Securities sees a possibility of 140.

Technical Warning: Support Levels Are Key

Technically, USD/JPY has broken below the 21-day moving average. Continued pressure below this line could open further downside space, with support at 153. Conversely, if the pair can regain above the 21-day moving average, a rebound becomes more likely, with 157 serving as resistance.

Next Week’s Trading Tips

This week, the Fed’s interest rate decision and developments in the Russia-Ukraine situation are market focal points. Since the ECB has largely ended its rate-cut cycle, the path of the Fed’s rate cuts next year will be crucial for EUR/USD. Additionally, the Fed’s policy stance (hawkish or dovish) will directly influence the subsequent performance of USD/JPY—hawkish environments favor the dollar, dovish environments favor the yen.

For fund managers and investors focused on the Japanese market, the changing interest rate differential driven by the BOJ’s rate hike actions and the Fed’s rate cuts will be an important reference for evaluating Japanese fund recommendation strategies.