ING: Fed Pause May Extend Into 2027 While Japan Faces Rate Hike to Stabilise Yen

The Quick Take

• ING Chief International Economist forecasts Fed pause extending into 2027 on weak jobs and benign inflation
• Japan may need to hike rates to stabilise yen as BOJ-Fed divergence creates currency pressure
• Fed-BOJ rate divergence is most complex G7 policy split for Asian asset allocators in 2026-27
• Extended Fed pause supports EM risk appetite while Japan hike risks yen carry trade unwind

ING's Chief International Economist James Knightley has outlined a dual-central-bank forecast that represents the most complex G7 monetary policy divergence scenario for Asian asset allocators: the Federal Reserve maintaining its rate-hold posture well into 2027 while the Bank of Japan faces pressure to raise rates in order to stabilise the yen against the dollar. The asymmetry of this outlook — American monetary policy anchored by weak jobs data and benign inflation while Japan is compelled toward tightening for currency stability reasons — creates a narrow path for policymakers in both countries and significant positioning challenges for fund managers running cross-Asia portfolios.

The extended Fed pause thesis is grounded in recent US economic data: non-farm payrolls have been softer than consensus expectations in recent months, and headline CPI has been decelerating despite sticky services inflation. Together, these data points give the Federal Reserve's data-dependent framework no clear mandate to hike, and any cuts remain conditional on further disinflation that Knightley does not anticipate will arrive before 2027. Meanwhile, Japan's situation is structurally different: inflation has sustained above 2% for an extended period, and the yen's weakness — which translates into higher imported energy and food costs — is exacerbating the inflation challenge rather than addressing it, creating a policy case for modest tightening.

The yen carry trade is the critical risk embedded in this scenario. If the BOJ hikes rates and the yen appreciates meaningfully, investors who have borrowed in yen to fund positions in EM equities, US Treasuries, or Australian dollars will face margin calls or forced unwinds — a dynamic that played out violently in August 2024 and could repeat if the BOJ surprises with more aggressive tightening. Asian equity markets, including India's Nifty and Korea's Kospi, would be vulnerable to sharp short-term outflows in a yen-carry unwind scenario, even if the fundamental economic case for those markets remains intact. The US dollar index (DXY) response to Fed-BOJ divergence is the early warning indicator to watch.

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