Japanese Yen: Inflation curve debate shapes outlook – Rabobank

Rabobank’s Senior FX Strategist Jane Foley discusses the Japanese Yen’s (JPY) recent strength and questions whether the Bank of Japan (BoJ) is truly behind the inflation curve. Foley highlights JGB auction strength, rising foreign ownership of Japanese debt, and BoJ inflation forecasts, while stressing that fiscal concerns and cautious rate hikes continue to limit a sustained JPY recovery.

BoJ credibility and JPY performance

"In August last year, US Treasury Secretary Bessent stated that the BoJ is “behind the curve on inflation” and indicated that the Japanese monetary authority would be hiking interest rates. At that time Bessent stated that there was risk of “leakage,” meaning that higher JGB yields could potentially drive up those in other bond markets including US treasuries. Moreover, since Japanese investors are the largest foreign holders of US debt, the US Treasury is likely to be concerned that at some point the draw of higher JBG yields may bias the asset allocation of Japanese big insurance companies away from US paper."

"Either way, the view that the BoJ is behind the curve on inflation has had a significant impact on market sentiment with respect to both the JGB market and the JPY. Overnight, a 30 yr JGB auction drew its highest bid cover ratio since 2019. This auction result begs the question as to whether the market is becoming less fretful about inflationary or fiscal risks in Japan."

"The JPY is currently the best performing G10 currency on a 1-day view. This is not a statement that has been associated with the JPY with much frequency this year. Indeed, the JPY is the worst performing G10 currency over the past 12 months."

"This may help explain the slow pace of its interest rate hiking cycle, though core-core CPI inflation stood at a moderate 1.8% y/y in May. This suggests that accusations that policy makers are behind the curve may be misguided. Various measures of CPI inflation have dropped back significantly from last year’s highs."

"While a hastened pace of BoJ rate hikes would be JPY supportive, despite today’s strong JGB auction, it is unlikely that investors’ worries about the administration’s fiscal intentions have yet abated. More reassuring messages on this front are likely to be needed before the JPY can demonstrate a convincing turnaround."