USD/JPY Outlook: BOJ sidelined as stronger yen revives Japan’s deflation problem

USD/JPY Summary

Japanese wholesale inflation eased in May, pointing to waning upstream price pressure that may eventually filter down to the consumer level. While that may keep Bank of Japan (BOJ) officials cautious when it comes to further interest rate hikes, USD/JPY direction on Wednesday will likely be determined by the detail within May’s U.S. consumer price inflation (CPI) report.

Japan Upstream Price Pressure Ease Sharply

Upstream price pressures in Japan continue to ease, according to data released by the BOJ on Wednesday. Japanese corporate goods prices—the cost of goods and services charged to other businesses—fell 0.2% in May, seeing the annual rate decelerate sharply from 4.1% to 3.2%. It was the smallest annual increase since September 2024 and well below the 3.5% pace eyed by economists.

Tellingly, import prices slumped 10.3% in May from a year earlier following a revised 7.3% drop in April, indicating the yen’s rebound is now pushing down the cost of raw materials. In other words, Japan is importing deflation again—a dangerous development for a nation that has struggled to shake a deflationary mindset after decades of prices going nowhere.

As the graphic below shows, trends in corporate prices are often replicated months later at the consumer level, especially core measures that exclude both fresh food and energy prices. As such, the disinflationary shift suggests the days of consumer price inflation sitting well above the BOJ’s 2% annual target may be numbered.

Source: TradingView

BOJ 2025 Rate Hike Favoured

Following the data release, swaps traders see little risk of the BOJ resuming its tightening cycle until later this year, deeming the risk of a 25 basis point hike in October as a coin flip, with a move in December deemed a two-in-three risk. Before trade tensions with the United States flared in April, markets were fully priced for one hike from the BOJ this year, with a second deemed a strong possibility.

Source: Bloomberg

Just as softening upstream price pressures and spluttering consumer demand may keep the BOJ on the sidelines, so too may sticky inflation pressures in the United States see Federal Reserve officials prevent them from adding to the 100 basis points of rate cuts already seen this cycle.

U.S. CPI Seen Accelerating

The big event for USD/JPY traders on Wednesday will be the release of U.S. consumer price inflation data for May, especially as this report may be the first to show the impact of higher import tariff rates filtering down to the consumer level.

As seen in the table below posted by WSJ’s Nick Timiraos on social media platform X earlier this week, the key core inflation reading is expected to lift 0.27% in May, seeing the annual rate accelerate slightly from 2.8% to 2.9%.

Source: WSJ, X

There’ll be ample interest in the goods price measure, as this will be the area where tariff-induced pressures will be seen first. Trends in services costs will also be eyed closely, especially as the detail from last Friday’s payrolls report was not impressive when you look beyond the headline level. As the largest category in the U.S. CPI basket, labour market conditions are often influential on wage pressures and trends in services prices.

Before the inflation report is released, Fed funds futures price only 39 basis points of rate cuts by the end of 2025, implying one cut with a second deemed a coin flip. For USD/JPY, a stronger core inflation print will likely boost the dollar as rate cut expectations dwindle further, and vice versa for an undershoot.

Source: TradingView

U.S Treasury Auction May Spice Things Up

It won’t receive the same attention, but with the U.S. Treasury auctioning $39 billion worth of 10-year notes on Wednesday, demand trends may be replicated in the U.S. dollar in the FX universe. For a reference point, the bid-to-cover ratio (the amount of bids to bonds on offer) at the last 10-year auction stood at 2.6 times.

It’s not been anywhere near as strong as seen in the past, but the correlation between USD/JPY and benchmark 10-year yield differentials between the U.S. and Japan has started to tighten over the past month.

USD/JPY: Directional Risks Shifting Higher

USD/JPY broke the downtrend from the May highs earlier this week but has been unable to extend the move, running into sellers parked above 145.00. However, holding above the 50-day moving average, and with momentum indicators shifting neutral to marginally bullish, the case for upside looks far more appealing than just a week ago.

Source: TradingView

For those contemplating longs, buying dips towards the 50-day moving average with a stop beneath it or 144.00 is one potential setup, allowing for trades to be set targeting 145.30 (Tuesday’s session high) or 146 depending on the desired risk-reward.

If the price pushes back towards 145.30, that would offer alternative setups depending on how the price action evolves. A break above the level allows for longs to be established with a tight stop below, targeting 146. If the price cannot break above 145.30 meaningfully, the setup could be flipped with shorts established beneath the level with a stop above for protection. The 50-day moving average or 144 support are both potential targets.

-- Written by David Scutt

Follow David on Twitter @scutty