The Japanese yen has surged approximately 3% within just a few trading sessions, driven by two primary forces: intensifying expectations of a Bank of Japan rate hike and speculation that the Government Pension Investment Fund may increase its allocation to domestic assets.

According to trading desk insights, Goldman Sachs believes this rally is not solely driven by short-term carry trade dynamics. Instead, Japan's domestic policy environment is undergoing a transformation: expectations of a BoJ rate hike are rising, while a potential asset reallocation by GPIF could generate sustained yen buying. This suggests that factors which have long suppressed the yen are gradually transitioning into sources of support.

Therefore, Goldman Sachs concludes that the correction of the yen's long-term structural undervaluation may have only just begun. In contrast, JPMorgan, while also bullish on the yen's short-term prospects, believes that market expectations regarding BoJ rate hikes and GPIF rebalancing are already largely priced in. Should policy delivery fall short of expectations, the yen could quickly retreat.

The key question now is whether this yen rally, driven by Japan's policy shift, can evolve into a sustained trend.

Goldman Sachs: Yen Strength 'Just Beginning,' Policy Shift Is Key

Goldman Sachs attributes the current yen appreciation to two main drivers: rising BoJ rate hike expectations and market bets that GPIF will shift its asset allocation further toward domestic investments.

The potential capital flows from GPIF deserve particular attention. Citing the 2020 precedent, the report notes that while GPIF formally announced changes to its foreign bond allocation targets at the end of March that year, related capital flows had already emerged between January and February, implying that actual portfolio adjustments may precede official policy announcements.

Consequently, the report closely monitors the August International Transactions in Securities data, scheduled for release on September 7th, viewing it as a potential early indicator of GPIF rebalancing flows.

Goldman Sachs argues that the yen's weakness over recent years has largely stemmed from U.S. economic resilience and the widening yield differential between the U.S. and Japan. Now, with the BoJ's policy shift and GPIF's potential domestic allocation adjustments, the structural headwinds the yen previously faced are diminishing and could even transform into tailwinds.

JPMorgan: Short-Term Bullish, but Yen's Rise Faces Policy Delivery Test

However, regarding the GPIF asset reallocation variable, JPMorgan's assessment is notably more cautious.

The agenda released on August 31st shows that GPIF held a management committee meeting on August 21st, marking the first August meeting in seven years. The review of its basic portfolio allocation, which had concluded in March that "no review was necessary," has also re-entered discussions.

JPMorgan believes this indicates GPIF may be reassessing its asset allocation, but near-term adjustments are more likely to occur within existing allocation ranges rather than through a formal revision of the basic portfolio.

If domestic bond allocation were to rise from 26.91% to the upper limit of 31%, this would theoretically correspond to approximately 12.3 trillion yen in yen buying; if Japanese equities rose from 23.81% to 31%, this would correspond to approximately 21.6 trillion yen, totaling roughly 33.8 trillion yen.

Meanwhile, JPMorgan views BoJ rate hike expectations as overly heated. A September rate hike is now almost fully priced in, with the 1-year OIS rate rising to approximately 2.13%, implying a tightening pace even steeper than the bank's own forecast. Should these expectations begin to cool, the yen could instead come under pressure.

JPMorgan Rebuilds Dollar Long: Rate Advantage Still Undervalued, September CPI Is the Key Variable

JPMorgan maintains a constructive medium-term outlook for the U.S. dollar. The bank argues that the dollar remains undervalued by approximately 3% to 4% relative to interest rate differentials, and that U.S. economic resilience is not fully reflected in the current exchange rate.

The U.S. unemployment rate holds at 4.1%, below the Federal Reserve's year-end projection of 4.3%. The report estimates that under a scenario of just one Fed rate cut this year, dollar yields would still exceed those of more than 50% of global currencies, approaching 25-year highs; if cuts reach three, that proportion would rise to approximately 58%.

Looking ahead, the U.S. August CPI report becomes the critical catalyst. Following the CPI release on September 11th, the FOMC meeting on September 16th, the Bank of England on September 17th, and the Bank of Japan on September 18th will follow in quick succession, potentially triggering a dense repricing of major central bank policy expectations within a short window. Internal divergence at the Fed remains pronounced, and inflation data will further test market bets on the future policy path.

For the dollar, the subsequent trajectory will depend on U.S. economic data and shifts in Fed policy expectations. Should U.S. inflation and employment data continue to show resilience, the dollar's rate advantage is likely to receive further support; conversely, if cooling inflation prompts markets to reprice looser policy, the dollar could face downward pressure.