USD/JPY edges lower after stronger-than-expected Japanese inflation, stimulus package

• USD/JPY falls as the Yen gains on expectations the BoJ will raise interest rates in December. 
• Bets are falling meanwhile for the Federal Reserve to cut interest rates, narrowing the differential. 
• This advantages the JPY, creating a headwind for USD/JPY going forward. 

USD/JPY is trading a touch lower in the 154.30s on Friday as the Japanese Yen (JPY) strengthens against the US Dollar (USD) due to the release of higher-than-expected Japanese macroeconomic data, and Tokyo’s announcement of a $250 billion economic stimulus package. 

The Yen’s gains are comparatively limited against the US Dollar, however, which is itself underpinned by a narrative of American exceptionalism, the anticipation of Dollar-positive policies under President elect Donald Trump, and a shallower downward trajectory for US interest rates which is different from the steeper fall expected last month. 

The expectation that interest rates will remain higher for longer in the US is positive for the Greenback because it attracts foreign capital inflows. 

Although Federal Reserve (Fed) officials, including Fed Bank of New York President John Williams and Fed Bank of Boston President Susan Collins, recently said they saw inflation cooling and interest rates falling further, market-based gauges have suggested a lower chance of the Fed reducing rates in December. 

According to the CME FedWatch tool the probability of the Fed making a 25 basis point (bps) (0.25%) rate cut in December has fallen to 59% from previously being 100%. 

In Japan, meanwhile, bets are increasing that the Bank of Japan (BoJ) will raise interest rates in December, when previously investors had not been so sure. 

Japanese Consumer Price Index (CPI) data for October, released overnight, came in broadly stronger, especially in the core measures. 

Japan CPI ex Food, Energy was 2.3% YoY from 2.1% in September, and in the case of CPI ex Fresh Food – which came in at 2.3% – the result was still above the expected 2.2%, although below the 2.5% previously.   

Further, employee pay is expected to improve, fueling growth and spending, according to advisory service Capital Economics, who expect the yearly Shunto pay negotiations to result in large raises and a series of interest rate hikes from the BoJ. 

“The stars are aligning for our long-held view that the Bank of Japan will hike rates again by year-end. And with a recent survey of Japanese firms pointing to even bigger pay hikes in next year’s spring wage negotiations than the large one agreed this year, it looks increasingly likely that the Bank’s tightening cycle has further to run,” says Marcel Thieliant, Head of Asia-Pacific at Capital Economics. 

Other data from Japan was moderately positive on Friday, with the Japanese Manufacturing Jibun Bank Purchasing Manager Index (PMI) coming in softer at 49.0 compared to the 49.5 forecast, but the Services PMI rising into expansion territory of 50.2 from 49.7 previously.