Japan: Signs of peak inflation, path of least resistance is a weaker yen

Inflation remains above target in Japan, but a growing number of our leading indicators imply it will roll over in the coming months. This will keep the BoJ hawkish but not enough to prevent further weakness in the yen.

Our inflation LEI ticked lower last month, stalling out at a 6-month point estimate just above 2%. Underlying indicators like Japan’s inflation surprise index and the nominal effective exchange rate (Portal chart) suggest inflation is biased lower from here. 

Above-target inflation will keep the BoJ hawkish, but peak inflation suggests that the risks to short-term yields are biased lower from here, not higher.

Low carry is a key reason the yen is expected to underperform G10 FX according to our fundamentals-based FX Edge model. In May, we recommended long JPY based on repatriation flows as a bullish catalyst. This proved short-lived and these flows have since reversed in the past few months. Tactically, the yen is also vulnerable from an unwind in speculative long positioning.

All this suggests the yen will continue to underperform most G10 currencies from here.