If you look closely at the chart of exchange rate movements, you’ll notice that among all the countries, Japan has borne the greatest sacrifice in maintaining the dollar index range through currency weakness.
Countries like the Eurozone, Switzerland, and the UK have moved below the dollar index range, so in reality, over the past three years, the dollar’s movement has relied most heavily on Japan, alongside Canada.
But on July 27, the long-standing trend of yen weakness collapsed, and the yen shifted into a strengthening phase. As a result, the short-term dollar rally also broke down, leaving the dollar index range increasingly unstable.
Why did the yen’s weakness collapse?
Let’s calculate. The three indicators with the strongest impact on inflation are:
Exchange rate → 100% effect
Crude oil & natural gas → 40–50% effect
Government bond yields → 20–30% effect
Japan, in order to support dollar strength, endured inflation caused by yen weakness (+100% from exchange rates). It tried to offset this with tighter monetary policy through bond yield increases (–30%).
The net effect was about +70% inflation, which Japan had to absorb.
Looking at Japan’s policy rate trends in the chart, since 2024 Japan has acknowledged this +70% inflation through frequent rate hikes. But this also triggered reduced purchasing power and liquidity risks.
Why did Japan abandon yen weakness on July 27?
Because inflation had become unbearable, and the risk of a liquidity crisis was too great. Japan could no longer sacrifice itself for the dollar index range.
By shifting to yen strength, Japan aimed to suppress inflation through exchange rates. This gave the country breathing room, allowing it to pause the cycle of repeated short-term rate hikes.
What does this mean for the dollar going forward?
Japan, once the biggest influence on maintaining the dollar index range, is no longer able to sustain inflation and rate hikes caused by yen weakness. Since July 27, Japan has turned toward yen strength to fight inflation.
This means the strength of the yen will now directly determine the weakness of the dollar.
On top of that, the Eurozone has raised rates, adding to inflationary pressures. The U.S. Federal Reserve also raised rates on September 16. Everywhere, inflation is causing turmoil.
The critical point
Looking at government bond yields and policy rates in the chart, the U.S. has been maintaining excessively high rates above the fair trend line due to prolonged dollar strength.
But to avoid a fiscal collapse, the U.S. must bring bond yields and policy rates back down to around 1%, which is the safe level. This implies that rate cuts are necessary.
Conclusion
Currently, countries are overusing rate hikes to maintain the dollar index range. This is not a normal interest rate cycle and harms fiscal health.
Therefore, the dollar index range is bound to collapse sooner or later.
Would you like me to refine this into a more analytical essay style, or keep it as a market commentary piece that reads like a financial analyst’s note?
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