USD/JPY, Nikkei trading heavy as news flow bolsters case for BOJ rate hike

• BOJ Governor Kazuo Ueda expressed growing confidence yesterday that the bank will meet its 2% inflation target
• Data and news flow on Wednesday bolster the case for a possible BOJ rate hike
• USD/JPY has weakened as yield spreads with the US compress, weighing on Nikkei futures

Japan has received a raft of bullish economic news today, sending Japanese government bond yields higher while simultaneously placing downward pressure on USD/JPY and the Nikkei 225.

Less than 24 hours after Bank of Japan (BOJ) Governor Kazuo Ueda expressed confidence the bank was on track to deliver on it’s 2% inflation target, markets received further positive news regarding trade, economic activity and wages on Wednesday, bolstering the case for the BOJ to lift its key overnight policy rate out of negative territory for the first time in nearly a decade.

Japan’s services sector starts 2024 in good form

Suggesting Japan’s services sector saw a reacceleration at the start of 2024, the S&P Global “flash” services purchasing managers’ index (PMI) rose to 52.7 in January from 51.5 in December, indicating activity levels improved at the fastest pace since September.

“Growth in new business also picked up from that seen in December, while foreign demand for Japanese services rose for the first time in five months,” the report said. “Service providers also noted the strongest rate of backlog accumulation since last June. As a result, firms looked to keep up with demand by raising employment levels for the fourth month in a row.”

Source: S&P Global 

While the separate ‘flash” manufacturing index wasn’t as strong, indicating an overall decline in activity relative to a month earlier, whether that will persist longer term is questionable given the strength seen in Japanese exports at the end of 2023.

Japanese exports balloon to record highs

According to data released by the government, the value of Japanese exports surged to a record high in December, benefitting from record values to the United States and first year-on-year increase in export values to China, it’s largest trading partner. With the Japanese yen weak against a basket of major currencies, it’s a clear positive for exporters, potentially helping to keep Japan’s output gap in positive territory to foster inflationary pressures.

Signs the BOJ may get what it wants: wage pressures

After a disappointingly weak wages report released last month, the BOJ received positive news on what’s undoubtedly sitting at the top of its wish list for 2024: signs wage growth may exceed the level of inflation over the past year.

Leaders of the Keidanren, Japan’s top business lobby group, and Japan’s largest labor union, Rengo, were speaking at a forum in Tokyo to mark the start of annual "shunto" spring wage negotiations, with the former suggesting it was the social duty of private firms to pursue wage hikes that beat soaring prices.

Rengo representatives affirmed they intend to pursue an annual wage increase of at least 5%, up from an average of 3.99% for FY23.

With the headlines unilaterally positive for the BOJ, the release coincided with a pickup in Japanese government bond yields, seeing the spread with equivalent US 10-year debt compress by around 6 basis points, weighing on USD/JPY.

USD/JPY falls as US-Japanese yields compress

The pair remains in a tight range on the four-hourly chart, finding offers at 148.50 with bids kicking in from 147.40. With Japanese yields ticking higher, it may be difficult for the pair to advance much beyond 148.50 without another leg higher for US Treasury yields beyond the rebound already seen.

Unless we receive an upside surprise, quarterly and monthly reads on US core PCE inflation are likely to show price growth back at the Fed’s 2% target on a monthly, three-monthly and six-monthly annualised basis later this week, helping to foster a renewed belief in the sustainability of the current disinflationary trend and keep yields capped. If that is the case, yield spreads between the US and Japan could compress further, weighing on USD/JPY. Should 147.40 break, a logical downside target for shorts would be 146.00 which acted as support and resistance in 2023.

Nikkei price action suddenly unconvincing

The hawkish stance from Ueda and strength in USD/JPY has not been lost on Nikkei 225 futures which are showing signs of rolling over. With futures gaining initially following the BOJ rate decision only to reverse hard soon after, the bearish engulfing candle on the four-hourly chart signals a potential near-term turning point. The subsequent price action adds to that view with futures, breaking through support at 36200. Should the move extend, shorts could be initiated targeting a pullback to 35300. A stop above 36200 would offer protection.

-- Written by David Scutt

Follow David on Twitter @scutty