The yen is under significant pressure following the Federal Reserve's hawkish rate decision, placing the Bank of Japan's upcoming policy meeting under an unprecedented level of scrutiny.

The Fed announced its first rate hike since 2023 and signaled further tightening ahead, prompting traders to price in three additional increases by mid-next year. This dynamic directly limits the yen's potential upside from a BOJ move, as the interest rate differential between the US and Japan is expected to remain wide for an extended period, even if the BOJ follows through as anticipated. The yen traded around 155.98 against the dollar during Asian hours on Thursday, hovering near a two-week low.

As markets have almost fully priced in a 25-basis-point rate hike, attention has shifted to Governor Kazuo Ueda's post-meeting press conference, where investors will look for clues on the pace and scale of further policy tightening. Glenn Yin, research director at Sydney-based ACCM, cautioned that if the BOJ disappoints market expectations, "the risk of a break above 160 in the near term should not be dismissed."

Fed's hawkish signals lift dollar, leaving yen with little room to recover

The rate hike, spearheaded by new Fed Chair Kevin Warsh, was approved unanimously and came with a clear signal of another increase within 2026. Interest rate futures now show roughly a 90% probability of an additional 25-basis-point hike this year. This has driven the dollar index to around 100.3, its highest level in nearly seven weeks. The policy-sensitive two-year Treasury yield held at 4.7153%, its strongest reading since 2024, while the 10-year yield slipped toward the 5% threshold.

The stronger dollar has hit the yen hardest. The currency dropped as much as 1% overnight to 156.42, erasing gains accumulated earlier this month that were driven by expectations of a BOJ rate increase, unwinding of yen carry trades, and speculation that Japanese pension funds might boost domestic asset allocations. The Fed's hawkish stance has forced a market repricing. Carol Kong, currency strategist at Commonwealth Bank of Australia, noted that the Fed's explicit guidance on the future rate path "caught the market off guard and ultimately pushed the dollar higher."

BOJ faces a challenging communication task

If the expected hike materializes, it will push Japan's policy rate to a 31-year high. However, strategists widely believe that the rate increase alone will not provide lasting support for the yen. Rinto Maruyama, senior rates and FX strategist at SMBC Nikko Securities, pointed out that the anticipated hike would lift Japan's policy rate to the lower bound of estimated neutral rate range, meaning officials are unlikely to signal a 50-basis-point move or a sequence of hikes. "If this meeting is interpreted as dovish, the next upside target for USD/JPY would be 158," he said, adding that the pair could eventually return toward 160 if US rates continue rising faster than Japan's.

Akira Moroga, chief market strategist at Aozora Bank, echoed a similar view. He stated that the BOJ "may adopt a stance that is not as hawkish as the Fed's, which could serve as a catalyst for immediate yen weakness," and identified 158.50—the area around the 200-day moving average—as the next key resistance level.

Hajime Takata, a BOJ board member known for his hawkish stance, has previously kept the door open for a larger or consecutive rate hikes, but Maruyama believes that option is unlikely to materialize under current conditions. Ueda's remarks at the press conference will be the key determinant in classifying this meeting as "dovish" or "hawkish."

Intervention risk returns to the radar, though aggressive yen shorting becomes harder

The yen's renewed weakness has brought currency intervention back into focus. Japan and the US conducted their first coordinated yen-buying intervention since 1998 this summer. Ministry of Finance data showed monthly intervention volume reached a record 15.4 trillion yen (approximately $98.6 billion) by August 26. Treasury Secretary Scott Bessent has since continued to signal support for a stronger yen, which has to some extent curbed market appetite for rebuilding short positions.

According to data from the Commodity Futures Trading Commission (CFTC), leveraged funds trimmed their yen short positions in the week ending September 8. Following the yen's sharp rebound that inflicted losses on carry traders, net short positions held by hedge funds have declined significantly from their peak. Strategists including Osamu Takashima at Citigroup noted in a research report that USD/JPY could rebound to 159 in the short term, but "it is becoming increasingly clear that the pair has already formed a major top this summer." Repeated intervention and the improving attractiveness of Japanese government bond valuations are pushing the exchange rate into a new regime-shifting phase.

Nevertheless, with the Fed's clear hawkish stance and growing expectations of policy divergence between the US and Japan, the yen faces notable two-way volatility risks around the BOJ decision. Markets will be closely watching Ueda's language at the press conference regarding upside inflation risks and the future trajectory of rate hikes.