The USD/JPY pair surged last week after a dramatic shift in Fed interest rate expectations, briefly topping the 160 mark and prompting warnings from Japanese officials. The move was driven by a historic repricing of US yields, with the two-year Treasury yield jumping 18 basis points in a single day, the largest increase since 1976. Markets now anticipate nearly four additional Fed hikes by mid-2027, a sharp rise from just over two hikes priced in a week earlier.
US Treasury yields dominated the pair's movement, with a strong 20-day correlation of +0.81 between yield changes and USD/JPY. While AI sector sentiment still plays a role, its influence has weakened recently. The fundamental divergence between US and Japanese economic data also widened, with the US Economic Surprise Index hitting a three-year high while Japan's data underperformed expectations.
The Bank of Japan is still expected to raise rates despite weaker economic data, with a 73% chance of a hike in December priced in. However, sustained undershooting of expectations could challenge this outlook. This week, Fed speakers will take center stage, though their impact may be limited without new economic data to shift market pricing.
USD/JPY bulls are now targeting higher levels after breaking out of a two-month range, though resistance around 160.20 may cap further gains. Broader risk appetite, particularly AI sector developments, could also influence the pair's direction in the coming days.