TSX up after index logs fresh record high close
Japanese political turmoil following Prime Minister Ishiba’s resignation is driving USD/JPY higher, with markets weighing the risk of looser fiscal policy and a less hawkish BOJ. While long-dated JGBs had rallied late last week, the leadership race could quickly bring fresh pressure on yields, keeping traders alert to the risk of renewed yen weakness.
- USD/JPY spikes on Japanese political uncertainty.
- Takaichi, Koizumi, and Hayashi lead the LDP leadership race.
- 30-year JGB yields had hit multi-decade highs before easing late last week,
- U.S. inflation prints this week could influence Fed rate path.
- USD/JPY rangebound with breakout risks shifting higher.
USD/JPY Outlook Summary
Renewed political instability in Japan has provided a powerful offset to downside pressure on USD/JPY sparked by a significant dovish shift in pricing for rate cuts from the Federal Reserve, pointing to a continuation of the rangebound price action seen since the start of August without a major surprise from upcoming U.S. inflation reports.
Japanese Political Turmoil Rocks Yen, Pressures Long Bonds
Japanese Prime Minister Shigeru Ishiba’s resignation over the weekend has injected fresh uncertainty into Japan’s policy outlook, with markets reacting violently in response. The risk that his successor could lean toward more expansionary fiscal settings and dial back the BOJ’s recent hawkish tilt has pushed USD/JPY sharply higher, while Nikkei Futures are also bid as equities take comfort from the potential for looser policy.
Market attention is falling on Sanae Takaichi, who finished second to Ishiba in last year’s LDP leadership contest and, if successful, would become Japan’s first female prime minister. Her support for easier fiscal policy and criticism of rate hikes has put her firmly on the market’s radar.
She is not the only contender. Shinjiro Koizumi, Ishiba’s farm minister and heir to one of Japan’s best-known political dynasties, is also expected to run, though little is known about his stance on monetary policy. Yoshimasa Hayashi, the current chief cabinet secretary, is another option, having previously held senior cabinet posts and emphasised the need to respect BOJ independence.
With the ruling coalition having lost its majorities in both houses of parliament, the LDP winner is still favoured to become prime minister but faces a less certain path than in the past.
In bonds, the backdrop is equally uneasy. Yields on long-dated JGBs had been climbing steadily to multi-decade highs on fiscal concerns before easing late last week amid a global bond rally. That reprieve may prove short-lived, with the leadership race likely to determine whether fiscal expansion accelerates, keeping pressure on Japan’s long end even as global forces provide temporary relief.
Source: Bloomberg
While there has been negligible reaction in Japanese swaps pricing to the political developments, traders continue to price the risk of another BOJ rate hike by December as a coin flip, with a full 25bp hike expected by April. Where there has been a sizeable move is in the back end of the JGB curve, with yields 20 years and longer spiking on the reopening of trade, unwinding much of the decline sparked by the U.S. payrolls report on Friday.
Source: TradingView
US Services Prices, Not Goods, Are Key
If not for political developments in Japan, risks to the range USD/JPY has been trading in since early August were skewing towards a bearish break, as yet another weak jobs report in the United States sent Treasury yields sharply lower on Friday while pricing for Fed rate cuts out to June next year jumped to levels not seen since May.
The narrowing of the US yield advantage over other currencies weakened the appeal of the greenback, with the US Dollar Index (DXY) briefly threatening fresh multi-month lows.
Source: TradingView
While the correlation between USD/JPY and outright US Treasury yields, Fed rate cut pricing, and yield differentials between the U.S. and Japan has been insignificant over a variety of shorter timeframes recently, it’s clear that when big moves have occurred in the pair, they’ve almost always been sparked by U.S. jobs market data.
That likely reflects that, at this particular moment, markets believe the Fed’s reaction function on interest rates is being driven by labour market conditions rather than the other side of its dual mandate: low and stable inflation.
At first glance, that suggests U.S. CPI and PPI data released later this week may not carry the potential to spark a major volatility outbreak. However, the detail in both reports will matter when it comes to not only how much the Fed will cut rates this cycle but also the speed at which they do so, especially information on services prices.
Source: LSEG (U.S. ET shown)
While the FOMC appears divided on the threat posed by the latest inflation acceleration, those members who have expressed concerns have tended to focus on the strength in services prices in July rather than softness in goods prices despite higher import tariffs.
If we see follow-up strength in services categories in August it may at the very least create the risk of another split vote at the Fed’s September policy meeting, or even the prospect of the funds rate being left unchanged if strong enough to warrant policy caution. Such an outcome would likely lift USD/JPY, especially as it would deliver a conflicting economic signal to the softness in the August payrolls report regarding consumer demand.
But if the strength in services categories in July were to reverse in August, it would likely deliver the opposite reaction and could even lead to markets beginning to price the risk of a 50 basis point move from the Fed later this month, which looks underpriced given clear evidence of continued weakening in the labour market.
The FOMC collectively sees neutral rates over 100 basis points lower than the current level of the funds rate, so if key data point to a rapid slowdown in the economy, it could easily spark a major dovish policy recalibration as we saw a year ago when the Fed went 50bp.
Put simply, trends in goods prices—despite the likely torrent of articles that will be written about them given higher import tariffs—are not the key piece of information that traders should be focusing on. It’s the potential combination of higher goods prices and strong private sector demand that has hawks on the FOMC in a flap, not simply that goods prices may increase. If not accompanied by robust demand, the likely impact may prove to be a one-off adjustment and lower than initially feared.
Treasury Auctions, Claims Data May Spark Volatility
Outside Japanese politics and U.S. inflation prints, the remainder of the calendar screens as largely inconsequential for USD/JPY, although watch for signs of waning demand for U.S. government debt ahead of auctions of 3-year, 10-year, and 30-year Treasuries in the days ahead.
Yields have fallen a long way quickly, so any signs of tepid demand could spark short-term bursts of dollar weakness. Weekly jobless claims is another release that could generate short-term volatility, especially if weak.
USD/JPY Range Holds Firm… For Now
USD/JPY remains sandwiched between the 200-day moving average on the topside and the 50-day moving average on the downside, keeping the pair rangebound with a slight upward tilt. With RSI (14) trending modestly higher and sitting above 50, the near-term directional bias is marginally bullish, a view bolstered by MACD, which crossed the signal line from below last week while in positive territory.
Source: TradingView
However, unless we see a clean break and close above the 200-day moving average, selling failed rallies towards 149.00 has proved to be a decent trade, as has buying dips beneath the 50-day moving average below. That remains the preferred way to play it until we see a definitive break of the prevailing range. If that were to take place on the topside, 151.00, 152.40, and 154.80 are the levels to watch. On the downside: 146.00, the April uptrend, 144.40, and 142.42.