JPY: Latest data reinforces BoJ hike prospects

The yen is stronger against most of the rest of G10 this morning (apart from AUD, see below) and market pricing indicates a continued gradual strengthening of expectations that the BoJ will hike in September. This is telling given the sharp decline in crude oil prices yesterday and the easing of Fed rate hike expectations. Crude oil prices had been grinding higher this month but half of the move higher in crude oil from the low on 5^th August was retraced yesterday. The implied probability of a rate hike at the September FOMC sits at 36%.

In contrast, the implied probability of a BoJ rate hike at the September meeting, which takes place two days after the FOMC, is 85%. The probability has not been higher since the last meeting in June. The conviction in the market strengthened further today following the PPI services data that saw the YoY rate rebound back to 3.6% in July, matching the highs from this year and just below the record high of 3.7% in 2024. The market expected 3.2%. The cost of freight transportation services surged by 67.4% YoY due to the conflict in the Middle East, which was the strongest since 1986. The data over the past three months were revised with the April reading revised sharply from 3.0% to 3.6%. This is a BoJ data set and plays an important role in inflation outlook deliberations and will likely convince the BoJ of the need to hike even in circumstances when the FOMC could have remained on hold two days earlier. Former BoJ policy board member Seiji Adachi, in an interview with Bloomberg stated that the BoJ will likely raise rates in September and again in January (MUFG’s current view).

There are some key upcoming speeches that could prove important ahead of the meeting. Firstly, Governor Ueda will not attend Jackson Hole and board member Naoki Tamura will attend in Ueda’s place. Tamura is one of the most hawkish members of the policy board. Was he chosen for a reason? There will also be a key speech tomorrow from Deputy Governor Himino with Hajime Takata scheduled to speak on 2^nd September. Takata dissented in favour of a hike at the last meeting. Finally, Kazuyuki Masu will speak on 10^th September and is someone who leans hawkishly and more recently has expressed views that the BoJ should hike.

Jackson Hole remains important from a Fed perspective. If there is no strong steer by Warsh on a hike in September (which seems likely) we would likely see front-end rates soften a little in the US and coupled with strong expectations of a BoJ rate hike could provide some impetus for a further decline in USD/JPY. Buying momentum certainly looks to be fading once again. Yen strength is evident in the non-dollar crosses today but if the Fed manages to remain on hold in September that yen strength should also become evident versus the US dollar as well.

FED VS BOJ POLICY RATE IN REAL TERMS CONVERGES

Source: MUFG Research, Macrobond, Bloomberg

AUD: RBA minutes suggest RBA rate hike risk underpriced

The Australian dollar was roughly stable yesterday with different crosscurrents keeping the FX moves limited. From an energy perspective, natural gas prices fell between 3-4% in Europe and that from a terms of trade perspective is negative for AUD given Australia is the second largest global exporter of LNG. In addition, the escalation of tensions between China and the US carry risks for Australia and any deterioration in China growth expectations on a breakdown in the trade truce between China and the US would weigh on AUD.

But the minutes from the August RBA meeting were also released yesterday and the contents certainly point to the RBA being closer to a rate hike than currently implied by market pricing. Our current view is that the RBA can hold off from hiking this year (similar our Fed view) and we continue with our long AUD/JPY trade view in the FX Weekly (here) based on yield remaining supportive and that easing inflation risks and the Fed remaining on hold will be supportive for the continuation of carry. However, we are beginning to see less upside scope in AUD/JPY due to the above on the yen side and hence will look to cut that trade view today.

A full rate hike in Australia is not priced until Feb 2027 but the minutes from the August RBA meeting suggests the risk of another hike sooner are higher. “Several members” judged that it was “quite possible” that inflation risks would be realised and require further monetary tightening. A pre-emptive rate hike was considered at the meeting given these views. That would have been a considerable surprise given pricing the day before the meeting on 11^th August indicated zero probability of a rate hike. It suggests a tendency of the market to underprice RBA rate hike risks.

Today the monthly CPI data was released, and the data has reinforced the view that the RBA could prove more active than was priced in the market. The July CPI showed smaller than expected moderation with the annual CPI rate slowing from 3.8% to 3.5%, versus an expected 3.3%. Fuel costs increased but this was offset by an easing in household electricity bills – the fuel cost jumped relates to the unwinding of substantial fuel-tax rebates. The focus of the RBA is likely to be on the trimmed mean YoY rate which failed to slow as was expected, remaining unchanged at 3.6%. The data suggests RBA inflation concerns will continue.  

That points to AUD continuing to perform well in current market conditions. However, the risks are starting to shift we are mindful of AUD starting to look stretched. The AUD/USD rate is starting to look over-extended relative to the 2-year AU-US swap spread. That can continue, but any disruption to risk that results in a spike in FX vol would likely see AUD suffer more than most.

AUD/USD STARTING TO LOOK STRETCHED RELATIVE TO 2YR SPREAD

Source: Bloomberg, Macrobond, MUFG Research