The yen may become more unstable if Treasury yields surge.

The bond market has been selling off as investors prepare for the policy environment that will follow U.S. President-elect Donald Trump's inauguration on January 20, with all signs pointing to the risk of higher tariffs.

Markets are anticipating that 10-year yields will rise to 5% once oncoming U.S. president Trump’s tariff and tax stances become official policy stances after his inauguration.

Those expectations are underpinning the greenback broadly. Although higher 10-year yields typically correlate strongly with USD/JPY, the pair's rise is being moderated by selling of yen crosses as equity markets face pressure. These sales are partially counterbalanced by Japanese NISA-related flows in Asia. The link between rising global bond yields and a weaker yen emerged when capital flowed freely and trade tensions were less prominent. Today, Japanese investors might seek higher yields to offset additional risks in the current environment, increasing their hedging of yen positions as yield curves steepen.

Another factor impacting USD/JPY’s sluggish rise is limited participation in yen carry trades, typically based on short-term rate differentials. The 3-month USD/JPY forward points are steady near levels seen in February 2023 as central bank policy meetings approach. Futures open interest is modest compared to April and July last year, and options risk reversals do not yet suggest a yen slide.

A weaker yen also raises the prospect that the Bank of Japan will hike at its January policy meeting. Market expectations for a 25 basis point increase have recently risen to 48%, according to LSEG IRP. Insights into the economy will come from the Bank of Japan’s branch manager meeting and overtime pay data due Thursday.

If USD/JPY tops the July 16 high of 158.85 and approaches the closely-watched 160 level after the U.S. jobs report on Friday, markets would probably see a greater risk that Japan's Ministry of Finance will intervene.

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(Robert Fullem is a Reuters market analyst. The views expressed are his own.)

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