The yen's U-turn continued Monday in Asia, with the currency strengthening to a more than six-month high against the dollar as the greenback softened in holiday-thinned trade.
The yen rose to its strongest intraday level since late February, extending a recovery that gathered momentum last week as markets became more convinced that the Bank of Japan is preparing to raise interest rates. The dollar was last 1.2% lower at 154.38 yen after touching 154.04 earlier.
"Now that it's clear that the BOJ will continue hiking, the yen is fashionable again," said Stefan Angrick of Moody's Analytics.
The gap between U.S. and Japan interest rates has been contributing to the yen's recent weakness, heightening its appeal for the so-called carry trade, in which traders use low-yielding currencies to invest in higher-yielding assets.
Even before the yen began rebounding, the market consensus favored BOJ tightening this month. Recent hawkish comments from officials have led a minority of investors to see some chance of faster and larger policy moves.
For Angrick, however, talk of a potential 50-basis-point move seems overdone.
The BOJ is likely to be concerned about "potentially throwing the baby out with the bathwater," he said. They don't want to be the ones that cause a recession by tightening too much, too quickly.
Investors have also focused on the Federal Reserve's prospective rate path, repricing their expectations after hawkish comments from Fed Chair Kevin Warsh were followed by more dovish remarks from Fed Governor Christopher Waller.
Nomura analyst Naka Matsuzawa had expected the yen to gain further this week as the Fed leans toward skipping a September rate increase and the case for a BOJ hike strengthens.
Much of what happens next for the yen will depend on U.S. inflation data due this weekand how markets interpret any new signals from either central bank. A speech from a BOJ board member on Thursday will be closely watched.
Barclays economists think the latest rally has raised the bar for further yen appreciation, with the next big catalyst hinging on the BOJ delivering on perceived hawkish signals.
The yen's moves on Monday may rekindle market chatter about potential intervention, particularly as authorities have in the past taken advantage of thinned liquidity during public holidays to step in.
Angrick said it was difficult to pinpoint why markets now seemed to be coming around to the view that the yen was oversold.
While the yen is indeed oversold, it has been very weak relative to economic fundamentals and interest-rate spreads for some time, he said.
"I'd really like to ask the people who are changing their view now, what have you been doing the last two years?"
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