Soft Japan GDP report puts dampener on JPY’s upward momentum

JPY: Japan Q4 GDP undershoot driven by volatile components

The yen has weakened overnight giving back some of last week’s strong gains. After hitting a low of 152.27 at the end of last week, USD/JPY has risen back above the 153.00-level. The main trigger for the partial reversal of yen strength has been the release of the weaker than expected Q4 GDP report from Japan. The report revealed that Japan’s economy expanded by an annualized rate of just 0.2% in Q4 following a downwardly revised contraction of -2.6% in Q3. For the calendar year as a whole, Japan’s economy expanded by 1.1% after contracting marginally by -0.2% in 2024. It was the strongest calendar year of growth since 2022. Still, the loss of growth momentum in the second half of last year has put a dampener on the outlook for growth in Japan at the start of this year. The breakdown of growth in Q4 revealed that the softer than expected economic rebound was led back by a large negative contribution from inventories which subtracted -0.8 percentage points from growth. Public fixed investment also subtracted -0.3 percentage points from growth. The drag from inventories in particular is expected to reverse at the start of this year. The drags offset positive contributions from personal consumption and capex of 0.4 and 1.0 percentage points respectively.         

The weaker Q4 GDP report has put a dampener on BoJ rate hike expectations encouraging a weaker yen. The yield on the 2-year JGB yield has dropped by 2bps overnight although market expectations for the next hike being delivered as soon as at the April policy meeting have not changed significantly. There are still around 17bps of hikes priced in. The muted market reaction reflects the fact the growth undershoot was mainly driven by volatile components that are likely to reverse. The BoJ is still under pressure to speed up the pace of rate hikes to help restore stability to the yen and JGB market. Bloomberg has reported comments from Japan’s former currency chief Takehiko Nakao overnight stating concern that the BoJ is “behind the curve”. He believes that “steady and gradual interest rate hikes can respond to inflation, curb excessive yen depreciation and stabilize long-term bond yields”. It follows comments at the end of last week from well-known BoJ board member Naoki Tamura, who is a well known hawk, who indicated that conditions for the BoJ to hike rates as soon as this spring could be in place if wage growth is in line with the target. The latest developments have taken some of the upward momentum away from the yen. The next important support level for USD/JPY is located at around 152.00 followed by the 200-day moving average at around 150.60.    

PRIVATE CONSUMPTION HAS BEEN LESS VOLATILE THAN GDP

Source: Bloomberg, Macrobond & MUFG GMR

USD: US CPI report leaves door open for further Fed rate cuts

The US dollar lost upward momentum at the end of last week after the release of the latest US CPI report for January left the door open to further Fed rate cuts this year. The dollar index is currently trading in the middle of the range that has been in place over the past month between 96.000 and 98.000. The dovish repricing of Fed rate hike expectations is more evident in the US rate market where the 2-year Treasury yield is threatening to break lower, and is testing support at 3.40%. US rate market participants have been moving to price in higher probability of the Fed delivering three rate cuts by the end of this year. Fed rate cut expectations were encouraged by the relatively benign US CPI report for January. The report revealed that headline and core inflation both slowed to 2.4% and 2.5% respectively. The monthly increase in the unadjusted core inflation rate of 0.37%M/M was the smallest January increase since 2020. One area of concern was the +0.59% increase in core services inflation excluding housing but it was driven by a 6.52% jump  in airline fares that is unlikely to be sustained.            

While the US CPI report has been welcomed by market participants, it is not weak enough to bring forward Fed rate cut expectations into earlier this year given evidence of  a pick-up in US employment growth in January. The next Fed rate cut is not expected to be delivered until the next Fed chair is likely to be in place in June. Fed Chicago Fed President Goolsbee stated on Friday that inflation falls back to 2%, there could be a case for several more rate cuts although he is not convinced that services inflation has been tamed yet. He is no longer a voting FOMC member this year, but dissented against the decision to cut rates in December. The comments fit with our view that slowing inflation will encourage the Fed to lower rates further this year even if the labour market starts to stabilize, and contribute to further US dollar weakness.           

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com