Bank of Japan Governor (BOJ) Kazuo Ueda caused a stir in FX markets earlier this week, flagging the possibility the bank may abandon negative interest rates should the evidence become compelling that inflationary pressures in Japan are self-sustaining, breaking with the deflationary and disinflationary environment that’s been evident for over 30 years. Ueda flagged sustainability in wage pressures as a key requirement the bank would be watching closely.
Flagging upstream inflationary pressures bad news for USD/JPY bears
Recent data on the wages front has been largely disappointing, suggesting markets may be getting ahead of themselves in speculating an impending end to negative interest rate policy and yield curve control. According to data released by the government last week, nominal pay growth in the year to July slowed to 1.3%, less than half the 2.9% multi-decade highs set two months earlier.
Adding to doubts on the sustainability of the inflation pulse rippling through the economy, upstream price pressures are also beginning to ebb with wholesale price growth slowing for an eighth consecutive month in August on an annualized basis.
The government’s corporate goods price index (CGPI), measuring costs for goods and services that businesses charge each other, rose 3.2% from a year earlier, well below the 10.6% annualised rate reported in December 2022.
Given input costs can influence prices further downstream, the declining momentum is a cautionary tale that the recent lift in consumer price inflation may be difficult to sustain, adding to downside risks for wage pressures ahead of annual pay negotiations early next year.
With Japan’s domestic economy struggling on the back of faltering household spending, it’s not difficult to see why doubts are emerging as to whether the BOJ will be in a realistic position to begin normalising policy just as other central banks are predicted to do the exact opposite by cutting interest rates. Given the government’s concern about weakness in the Japanese yen against the US dollar, perhaps Ueda merely flagged the potential of nomalising policy to generate a currency reaction without having to intervene directly? It got the desired result, if only briefly.
USD/JPY uptrend intact but appears vulnerable
Looking at the daily, USD/JPY bounced nicely off uptrend support on Monday, warding off the threat of a potential change in direction for now. With flagging upstream inflation dynamics in Japan, fundamentals suggest it remains the path of least resistance, especially when applied against the ongoing strength being seen in the US economy.
But as I wrote a few days ago, USD/JPY remains vulnerable to reversal risks given just how much bullish sentiment there is towards the US dollar. All the talk is soft landings, the risk that poses to a resurgence in inflation and the potential need for higher interest rates. It’s the type of environment that’s perhaps as good as it gets for the world’s reserve currency. If the reality doesn’t meet those lofty expectations the burgeoning interest rate gap that exists between the nations could easily narrow, sending the USD/JPY lower. But we need a catalyst first.
Major test for USD bulls incoming
The first test is Wednesday’s US inflation report for August. While much will be made of the headline acceleration on the back of higher energy prices, it’s the core figure that should be more influential on markets. If we get a 0.2% monthly increase it will increase the odds of the Fed sitting pat in September and November, and with it an end to the tightening cycle. That, in turn, may also see uptrend support on the USD/JPY daily give way, opening a potential move back towards 145.00. If the core reading were to print at 0.3% or higher, the flipside is USD/JPY may act like a battering ram for resistance parked just below 148.00.
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