Stronger inflation fails to sustain Japanese Yen gains as bond yields decline

• As the Japanese Yen surrenders its earlier gains, USD/JPY rebounds from a five-week low.
• Lower Japanese bond yields put pressure on the Yen, outweighing firmer domestic inflation.
• With the Fed and BoJ expected to leave rates unchanged next week, markets look for signals of December increases.

A further decline in Japanese government bond yields weighs on the Japanese Yen on Friday, allowing USD/JPY to recoup earlier losses after reaching a five-week low of 156.08 in the Asian session. By contrast, US Treasury yields steady following the previous day’s steep fall, supporting the US Dollar near its recent lows.

At around 15.77 at the time of writing, the pair is broadly unchanged on the day. The US Dollar Index (DXY), a gauge of the Greenback’s value against six major currencies, stands near 101.70, having reached a three-week trough of 101.45 on Thursday.

Concerns over AI-related investments prompted a flight to safety in the Japanese Yen and government bonds on Thursday, lifting the currency against its major peers. After dropping 16.6 basis points (bps) to 4.95%, the benchmark 10-year US Treasury yield recovered towards 4.99% on Friday. Japan’s 10-year government bond yield, meanwhile, declined by more than 10 bps to roughly 2.76%, a level last seen in early August.

September’s stronger domestic inflation figures have also failed to support the Yen. Japan’s National Consumer Price Index (CPI) recorded a 2.1% year-on-year rise, compared with 1.9% in August. Excluding fresh food, inflation climbed from 1.8% to 2.1%, in line with expectations and above the Bank of Japan’s (BoJ) 2% target. The measure excluding food and energy quickened from 2.0% to 2.4%.

With headline and core inflation below the BoJ’s projected rate, Brown Brothers Harriman strategists warn that the central bank is "unlikely to crank up the pace of tightening with headline and core CPI inflation tracking below its 2026 projection of 2.5%." In their assessment, the swaps curve currently "prices in just 2% odds of a 25bps BoJ rate hike to 1.50% on October 30, and 80% probability of a hike on December 18," pointing to a gradual policy path.

Against that backdrop, BBH’s expectation is for "USD/JPY likely to trade within a 155.00-160.00 range in the near term," although it cautions that "a deeper rout in the AI trade can fuel more safe-haven demand for JPY and drive the cross below 155.00."

Friday’s preliminary US figures put the S&P Global Composite PMI at 57.6 for October, down from September’s 58.4. A rise in the Manufacturing PMI from 55.9 to 56.0 exceeded the 55.6 forecast. In contrast, the Services PMI slipped from 58.8 to 57.9, in line with expectations.

An upward revision took the University of Michigan’s final Consumer Sentiment Index from 46.3 to 48.0. Its one-year and five-year inflation expectations were unchanged at 4.7% and 3.5%, respectively.

Following September’s 25 bps increase, the Fed is likewise expected to keep interest rates on hold at its meeting next week. With higher energy prices stemming from Middle East tensions leaving inflation risks skewed upwards, traders will scrutinise indications of the future rate path. Current market pricing assigns an 80% probability to an increase in December.