Falling bond yields trim Japanese Yen gains despite firmer inflation

• A five-week low gives way to a USD/JPY rebound as the Japanese Yen surrenders its earlier advance.
• Stronger domestic inflation fails to support the Yen as Japanese bond yields decline.
• December rate-hike signals are in focus as the Fed and BoJ are expected to keep rates unchanged next week.

156.08 marked a five-week low for USD/JPY in Friday’s Asian session. The pair subsequently recoups its earlier losses as the Japanese Yen weakens alongside a further decline in Japanese government bond yields. US Treasury yields, by contrast, steady after the previous day’s steep fall, supporting the US Dollar near its recent lows.

Around 15.77 at the time of writing, the pair is broadly flat on the day. The US Dollar Index (DXY) stands near 101.70, having reached a three-week low of 101.45 on Thursday. The index measures the Greenback against a basket of six major currencies.

Concerns over AI-related investments drove investors towards the Japanese Yen and government bonds on Thursday, lifting the currency across the board. After dropping 16.6 basis points (bps) to 4.95%, the benchmark 10-year US Treasury yield recovers towards 4.99% on Friday. Japan’s 10-year government bond yield, meanwhile, declined more than 10 bps to around 2.76%, a low not seen since early August.

Even firmer domestic inflation figures offer the Yen little support. September’s National Consumer Price Index (CPI) in Japan increased 2.1% YoY, compared with 1.9% in August. Excluding fresh food, inflation reached 2.1% from 1.8%, 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 inflation running below the BoJ’s forecast, 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%." A gradual policy path is also reflected in the swaps curve, which they say 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,"

Against that backdrop, BBH’s near-term 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 US data put the preliminary S&P Global Composite PMI at 57.6 for October, down from September’s 58.4. Manufacturing PMI edged up from 55.9 to 56.0, exceeding the 55.6 forecast. Services PMI, however, slipped from 58.8 to 57.9, as expected.

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

Following September’s 25 bps increase, the Fed is expected to keep interest rates on hold at next week’s meeting. With higher energy prices associated with Middle East tensions leaving inflation risks skewed upwards, traders will scrutinise signals on the rate outlook. Current market pricing assigns an 80% probability to a December hike.