by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment opens with our takeaways from the Bank of Japan’s latest rate decision. We then turn to trade, examining the recent easing of tensions between the US and China ahead of their talks. Next, we briefly cover the prospect of renewed US military operations in Iran, as well as a discussion about a hack into OpenAI. As always, we conclude with a review of recent domestic and international economic data.

Yen Weakens: The Bank of Japan (BoJ) is failing to reassure investors that it is prepared to tighten policy further in response to mounting inflation concerns. Overnight, the central bank raised interest rates to their highest level in more than 31 years, but offered mixed signals on the timing of any additional moves. The ambiguous guidance triggered a sell-off in the Japanese yen, as investors questioned the BoJ’s policy credibility. The market was focused on the meeting due to the possibility of closer policy coordination between Japanese and US authorities.

• The BoJ raised its benchmark interest rate by 25 basis points, from 1.00% to 1.25%. The hike was widely expected, as the central bank has been normalizing interest rates since 2024. While Governor Kazuo Ueda hinted at further hikes during the post-meeting press conference, citing a renewed focus on stabilizing inflation, the 7–2 vote (with the two dissenters favoring a hold) has raised doubts about whether the central bank will raise rates at its next meeting.
• The lack of conviction on future rate hikes is at odds with many of its peers. Based on the latest market-implied policy rates, the BoJ is the only G-7 central bank not expected to hike at its next meeting, with rate probability pricing in only a 31% chance, almost half that of its nearest peer, the European Central Bank, which sits at 60%. The potential widening of the interest rate differential has likely contributed to the depreciation of the yen.
• Prior to the meeting, the yen had strengthened on expectations that the BoJ would adopt a more assertive approach to policy tightening. Much of that shift followed comments from US Treasury Secretary Scott Bessent, who not only hinted that the BoJ should tighten more aggressively, but also appeared to suggest that he knew their decision prior to the vote. His remarks helped ease selling pressure on the yen and briefly fueled speculation that the BoJ could deliver a 50-basis-point rate increase at its latest meeting.
• A persistent decline in the Japanese yen could pave the way for more intervention by the US Treasury and the BoJ. It is commonly believed that the threshold for such action is when the yen weakens past 160 per dollar. If that happens, Japan’s Ministry of Finance could use its holdings of sovereign bonds to fund purchases of yen in the open market. The Treasury could also intervene, partly to stem Japanese sales of US Treasurys. Nevertheless, any move to strengthen the yen could weigh on sovereign bond prices.

The Calm Before Talks: Washington and Beijing are looking to ease tensions less than a week before the sides are set to meet for talks. On Thursday, as a sign of good faith, the US decided to delay its excess capacity tariffs until after the meeting. Meanwhile, China has offered an olive branch of its own, allowing the yuan to appreciate against the dollar. The moves come as the two sides prepare to hold talks on trade, geopolitics, and AI, in what could reshape the relationship between the world’s two largest economies.

• The decision to delay tariffs follows the US determination to replace the tariffs struck down by the Supreme Court. A July investigation into the use of forced labor in Chinese-made goods led to China receiving a 12.5% tariff, a rate China said was consistent with the truce the two sides struck earlier in the year. The new excess capacity tariff would add 7.5%, bringing the total to 20%, which will probably be discussed during the scheduled talks.
• Meanwhile, China’s decision to allow the yuan to appreciate against the dollar has also eased tensions. The yuan rose to its highest level against the dollar in nearly four years after the People’s Bank of China strengthened its currency fixing for an eighth day in a row. The move is likely to put White House officials at ease, following allegations that a weaker yuan has given Chinese goods a competitive advantage in trade.
• The decision by both sides to offer concessions ahead of the talks comes as the two countries prepare to address two major flashpoints: the war in Iran and AI competition. Both issues have grown in importance, as the US and China have taken opposing sides on the conflict and remain locked in intense competition over AI. The discussions should allow the two sides to find common ground and prevent an escalation of tensions, as both issues carry the risk of a direct conflict.
• As the talks approach, we expect to receive more details on discussions regarding the war in Iran and AI, as opposed to trade. If the two sides can reach a consensus that helps alleviate tensions in the Middle East, that could ease oil supply concerns, which in turn could be supportive of bond prices. Meanwhile, signs that the two countries won’t restrict mineral or technology exports to each other could be positive for AI-related stocks. However, any setback in the talks could weigh on market sentiment.

Escalation in Iran: President Trump has mentioned that he is considering resuming military operations in Iran as a way to end the conflict. While there has been some success in reopening the Strait of Hormuz, transportation is still well below prewar levels, and the conflict has since broadened into other areas, including the Red Sea. The decision comes as the cost to the US has made it difficult to maintain its blockade for much longer. The president is expected to meet with Israeli Prime Minister Benjamin Netanyahu next, in what could pave the way for his decision.

Hacking with AI: Independent researchers have already begun experimenting with ways AI can be used for cyberattacks. One test showed that they were able to use Claude AI to hack into an OpenAI chatbot of an employee, allowing it to read and suggest changes to its private cache. Once the test was complete, the researchers reported the vulnerabilities to OpenAI. The finding shows how people may attempt to exploit AI as it becomes more readily available, and it is likely to raise more questions about government oversight.

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