Market Brief: Yen Climbs, Dollar Retreats As Data-Light Week Kicks Off

Amid a quiet start to the week, the Japanese yen is finding modest support even after Prime Minister Shigeru Ishiba’s governing coalition lost its majority in the Upper House, suggesting that currency markets had largely priced in the outcome ahead of yesterday’s vote. The Liberal Democratic Party—dominant in Japanese politics for all but five of the past seventy years—shed 16 of the 66 seats it defended, as both new and established opposition parties capitalised on public frustration over surging living costs. Wages have lagged behind inflation since the pandemic, and rice prices—arguably as central to Japan’s inflation psychology as gasoline is in America—have climbed by more than 100 percent over the past year, driven higher by domestic supply shocks and protectionist market structures*. The resulting strain on household finances has prompted calls for tax relief and stimulus payments—measures that, while politically expedient, would exacerbate the country’s already-precarious fiscal position. Long-term Japanese government bond yields have leapt higher over the last two years as the central bank has hiked rates and reduced its monthly purchase volumes, and could go higher yet if leaders are forced to open the spending taps.

The greenback’s early-July rebound is running out of steam as traders move to price at least one dovish dissent in next week’s Federal Reserve decision after Governor Waller’s Thursday speech at a meeting of the Money Marketeers** of New York foreshadowed a dovish turn among his counterparts, and bolstered his odds in the race to succeed Jerome Powell. We would recommend reading the whole thing, but note that he set out a well-reasoned case for expecting the second half of the central bank’s dual mandate to take precedence in the coming months. “The slowdown in GDP (gross domestic product) is evident in consumer spending, which constitutes about two-thirds of economic activity,” he said. “Tariff increases are a one-time boost to prices that do not sustainably increase inflation… Among the reasons for this are that the rate of growth in labour compensation is down considerably in the past year or two, and, with the softening labour market, I do not expect workers will be able to get large wage increases going forward”. Although “the labour market looks fine on the surface, once we account for expected data revisions, private-sector payroll growth is near stall speed, and other data suggest that the downside risks to the labour market have increased,” he warned. “The June 4th Beige Book reported declining labor demand in every single Federal Reserve District, and the July 16th Beige Book emphasised that labour demand continued to be less than labour supply in many industries". It is difficult to argue with any of that.

A light data docket beckons in the days ahead, but there are several key releases to keep an eye on:

This morning’s business outlook and consumer expectations surveys from the Bank of Canada are expected to show signs of improvement after plunging in the first three months of the year as Donald Trump fired the opening salvoes in his trade war. Measures of business investment remain quite depressed, but elements of a more optimistic outlook have percolated across the landscape in recent months as tariff increases have been walked back, as an easing in interest rates and transaction taxes has translated into modest support for real estate markets, and as the government’s competitiveness and fiscal easing efforts have brightened the mood. Front-running efforts have lifted export volumes, employees at most manufacturing facilities have returned to work, and wages and job growth measures have stabilised. The Bank’s preferred measures of core inflation have pushed higher, however, intensifying our focus on what businesses say about how price changes are flowing through their supply chains. Odds on a cut by the end of October—currently around coin-toss levels—could respond based on nuances embedded in the survey data.

Purchasing manager surveys spanning most major industrialised countries on Wednesday and Thursday could shed light on how the global economy’s momentum is evolving amid persistent trade and tariff uncertainties. June’s composite global measure climbed to a three-month high at 51.7, but remained weak relative to history as the services sector slowed even as tariff front-running effects boosted manufacturing sentiment. In July’s data, investors will be watching for divergences: whether US activity continues its modest uptrend, whether the euro area and Japan follow suit, or if renewed signs of vulnerability emerge.

Input price shifts will also warrant close monitoring. From what we can observe thus far, there is very little evidence of manufacturers in other countries absorbing tariff increases: US import costs have fluctuated only modestly*** in recent months, suggesting that American firms are cutting profit margins or passing price increases along to final consumers—a dynamic that was illustrated, albeit in a relatively modest way, in last week’s consumer price index data.

The European Central Bank is overwhelmingly likely to leave rates unchanged on Thursday after easing policy by almost 200 basis points in the last year. With recent data largely aligned with the Bank’s June forecasts and uncertainty lingering over trade policy, officials are likely to refrain from offering clear forward guidance, preferring instead to preserve flexibility ahead of September’s meeting. Traders will watch closely for any unease over the euro’s recent strength, though recent comments from policymakers suggest that they see still-elevated services inflation counterbalancing falling import costs, helping to keep overall price growth on track into the autumn. Meanwhile, financial conditions have eased markedly this year, hinting that demand may prove more resilient than expected.

*After decades—arguably centuries—of protectionist measures and heavy state intervention, 99 percent of the rice consumed in Japan is produced within the country, meaning that local disruptions can destabilise prices to a remarkable degree.

**I'm not saying that I would like to change my title to "chief money marketeer", but I'm not not saying that either.

***Import prices would be expected to fall by the amount of the tariff increase if foreign suppliers were absorbing the hit.

Economic Calendar