JPY: Japanese government lends support for near-term BoJ hike

The yen has strengthened modestly overnight supported by building expectations for a faster pace of BoJ policy tightening. The main trigger has been a Bloomberg report stating that Prime Minister Takaichi’s government is supportive of a near-term BoJ hike, with the next move likely in either September or October, according to people familiar with the matter. The report goes on to add that the BoJ’s fears over yen weakness driving up prices and the government’s desire to strengthen the impact of the recent US-Japan currency intervention are aligning them on the need for a near-term hike. The impact on Japanese rate market pricing has been relatively limited given that market participants had already moved in recent weeks to fully price in a hike by October and there are currently around 19bps of hikes priced in by September. The Bloomberg report fits with our own initial view that there was likely an agreement to allow the BoJ to continue to normalize policy in exchange for the US providing support for the yen through joint intervention at the end of July.

Kyodo news had also reported earlier this week that joint intervention was reportedly made possible by BoJ Governor Ueda’s hawkish comments at the 31^st July policy meeting. Governor Ueda had stated explicitly that, if necessary, the BoJ would “accelerate the pace of rate hikes”. The Us was reportedly concerned that delays in raising rates would lead to excessive yen weakness, which in turn could fuel further inflation and higher long-term interest rates, with repercussions across financial markets. The report went on to conclude that the BoJ has “effectively left itself with no option other than a rate hike at its next Monetary Policy Meeting on 17^th-18^th September”.

It has been notable that the yen has quickly given back intervention driven gains over the past week even as the Japanese rate market has priced in a faster pace of BoJ rate hikes providing a challenge for Japanese policymakers. The 2-year JGB yield has increased by around 15bps since intervention to support the yen at the end of July. With USD/JPY rising back towards the 160.00-level, market participants will be watching closely to see if Japan is willing to step back into the FX market to support the yen. At the very least Japanese policymakers will be hoping the heightened threat of intervention helps to slow the pace of yen weakness. Recent price action highlights that it will be difficult for the BoJ to avoid hiking rates in September and disappointing market expectations which would encourage further yen selling.          

YIELD SPREADS HAVE RECENTLY MOVED AGAINST THE USD

Source: MUFG Research, Macrobond, Bloomberg

USD: Benign US CPI report favours Fed leaving rates on hold

The main event yesterday was the release of the latest US CPI report for July. The US dollar weakened initially after the report was released resulting in the dollar index falling to a low of 99.613 but it has since fully reversed all of those losses and climbed back up to the 100.00-level. The US dollar has proven resilient even as market participants have moved to further scale back Fed rate hike expectations. The US rate market is currently pricing in around 9bps of Fed hikes by the September FOMC meeting compared to around 12bps prior to the release of the US CPI report. There was initial relief amongst market participants that the CPI report for July did not provide any major surprises that could alter the outlook for Fed policy.

The report confirmed that headline and core inflation increased in line with consensus forecasts by 0.1%M/M and 0.2%M/M respectively. Headline inflation has picked up to 3.4% in July from 2.4% in February since the US-Iran conflict started. However, it has been driven almost entirely by higher energy prices so far which have contributed an additional +0.9ppts to headline inflation. In contrast the contributions to the headline inflation from core goods and core services have been largely unchanged over the same period. It should provide further reassurance to the Fed that there has been little evidence yet of higher energy prices spilling into core inflation which remains well-behaved.  Core inflation has increased by an annualized rate of 2.4% over the last five months since the US-Iran conflict started. One area which did show a pick-up in inflation pressure in July was core goods inflation which increased by +0.2%M/M, the strongest monthly reading since September. Personal computers and peripherals increased by 3.5%M/M likely reflecting Apple’s recent price increases. The Fed has signalled that it is more closely monitoring upside inflation risks from AI-related demand.

Overall, the report supports our view that Fed is likely to leave rates on hold in September. However, it is unlikely that the US rate market will scale back rate hike expectations much further in the near-term given a hike still can’t be ruled out. The lack of progress to reopen the Strait of Hormuz and elevated energy prices continues to pose upside inflation risks in the near-term. At the same time, the lack of clear forward guidance from Fed Chair Kevin Warsh makes it harder to assess how they are likely to set policy going forward. The lack of follow through US dollar weakness after yesterday’s initial sell-off suggests USD stability is more likely over the summer.