USD/JPY, Nikkei 225: It’s no longer about inflation but the global economic outlook Nov 15th 2023

  • US inflation is likely to diminish in importance for USD/JPY and Nikkei 225, replaced by economic activity
  • Yield differentials between the US and Japan continue to compress, pointing to downside risks for USD/JPY
  • China’s data dump may set the near-term tone for the Nikkei 225

The US consumer price inflation (CPI) report for October had an immediate and significant impact for markets, including USD/JPY and Nikkei 225. The Bank of Japan (BOJ) and Japanese government should buy themselves a lottery ticket with the undershoot for headline and core prices resulting in a sharply weaker US dollar and large drop in bond yields, simultaneously solving two problems for fiscal and monetary policymakers at once: negating the need to intervene to support the Japanese yen while lowering Japanese bond yields, taking pressure off the BOJ to up bond purchases as part of its yield curve control program.

Your quick guide to the latest CPI details

Both headline and underlying inflation which excludes food and energy undershot market expectations by a tenth of a percent, coming in unchanged and up 0.2% respectively. Importantly, services inflation excluding housing and energy increased 0.2% from a month earlier, just a third of the pace reported in September. That’s important as the “supercore” inflation figure, as it has become known, has been cited frequently by Fed officials given its close relationship to changes in wage pressures.

Without dismissing the inflation threat entirely – there is still a decent risk of reacceleration next year – the softness in underlying inflation, on top of signs of cracking in the US labour market, suggests concerns will be curtailed in the near-term.

Focus should shift to activity and corporate earnings

With that in mind, focus will now likely shift to the broader economy, especially job market conditions and the strength of the US consumer. For a large open economy with strong trade ties to the United States, this is especially so for Japanese markets. With less focus on the yen outlook, the risk of BOJ intervention and whether the Fed will hike again, it means developments in the US, and also China, will play a far stronger role in dictating the outlook for Japanese equities rather than domestic conditions.

China’s economic performance just as important as the US

Near-term, focus for JPY and Nikkei 225 will be on the details of the latest China data dump for October with retail sales, industrial output and property investment the key numbers to watch out for. While Japan will release preliminary Q3 GDP numbers, including the deflator providing the most encompassing picture on broader inflationary pressures across the economy, it really is of secondary consideration for markets such as USD/JPY and Nikkei 225.

Rate differentials signal downside risk for USD/JPY

Looking at USD/JPY from a technical perspective, the four-hourly chart shows the scale of US weakness following the CPI report, logging one of its largest daily declines in years on Tuesday, taking out layer after layer of support in the process. You can see the unwind stopped 150.15, the juncture of horizontal support dating back to early October and uptrend support dating back to late last month. The pin bar suggests USD/JPY may be due a corrective bounce in the short-term. But unless interest rate differentials have been completely disregarded by traders – which is doubtful – the pair still appears elevated relative to yield spreads between the US and Japan.

For instance, the difference between 10-year government bond yields has compressed to under 360 basis points following the inflation report. The last time the differential was this skinny, USD/JPY was trading in the low 149s. Going further back, USD/JPY was in the mid 147s when the differential was similar in September this year. On that reasoning alone, it suggests risks remain to the downside for USD against the yen.

spreads jpus nov 15

Source: Refinitiv

Should we see a break of support at 150.15, it will open the door for a push below 150 with 149.85, 149.37 and 148.80 the downside support levels to watch. A stop above 150.15 would provide protection against a reversal of the prevailing short-term trend. If the pair squeezes back towards 150.76, it will improve the risk-reward dynamics for a short trade, allowing for a stop to be placed above that level.

usdjpy nov 15

Nikkei 225 eyeing fresh multi-decade highs

For the Nikkei 225, while a stronger yen is a fundamental headwind, given its relative valuation and importance of offshore demand for its goods and services exports, what’s important right now is whether corporate earnings will hold up. China’s economic performance is just as important for the Nikkei as that of the US, making today’s data dump crucial after the index broke resistance at 33000 on Tuesday. A break of resistance at 33400 will have traders eyeing off fresh multi-decade highs for the index above 33800 with only 33600 standing in the way. For those considering longs, a stop below 33000 will provide capital protection. A retracement towards this level would only help to improve the risk-reward of the trade.

Nikkei Nov 15

– Written by David Scutt

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