Japan’s factory activity declined in July, with the S&P Global Manufacturing PMI falling to 48.9 from 50.1 in June. This shift indicates a return to decline after a brief stabilization. The final PMI figure closely matched the preliminary estimate of 48.8. The decrease was due to weaker demand both domestically and internationally, leading to a sharp drop in output—the fastest decline since March. New orders continued to decline, but not as sharply as before. Employment rose, but at a slower pace, reaching a three-month low. While input cost inflation decreased to a 4.5-year low, output prices increased at the fastest rate in a year as companies passed costs onto consumers.

Boost In Business Confidence

Business confidence rose to a six-month high, fueled by hopes for increased demand and reduced trade tensions following a new trade deal with the U.S., which lowered tariffs from a threatened 25% to 15%. The Bank of Japan kept its short-term policy rate at 0.5%, which was expected. Governor Kazuo Ueda raised the bank’s inflation forecast to 2.7%, citing rising food prices and the positive impacts of the trade deal with the U.S. The yen briefly strengthened before settling around 150.67, slightly down from earlier highs. The data from July shows that Japan’s economy is sending mixed signals. The manufacturing sector is shrinking again, indicating weakness, while the Bank of Japan is raising its inflation forecast, suggesting a more hawkish approach. This tension between a weak economy and a concerned central bank creates uncertainty, making it difficult for the yen to find a clear direction around the 150.70 mark against the dollar. This situation means that betting on a clear movement in the yen could be risky in the coming weeks. A better option for traders might be using options, as the conflicting data is likely to cause volatility. Indeed, one-month implied volatility on USD/JPY has risen to 9.5% this week, indicating that the market is preparing for choppy price action rather than a steady trend.

Implications For The Market

We have seen similar patterns in 2023 and 2024, where speculation about a possible Bank of Japan policy shift clashed with weakening economic data. These periods resulted in sharp, unpredictable swings in the yen that often reversed quickly. The takeaway from that experience is to be cautious with sustained moves and be ready for volatility instead. For those trading the Nikkei 225, the situation is also complex. A weaker yen generally benefits Japan’s large exporters, but the decline in factory output and soft domestic demand could negatively impact corporate earnings. This suggests considering pair trades, like favoring exporters over companies focused on the domestic market, rather than making a broad bet on the entire index. The bond market and any future comments from Governor Ueda will be key to watch. The 10-year Japanese government bond yield briefly surged to 0.78% yesterday, its highest since early 2024, indicating that traders take the inflation threat seriously. Any further indications that the Bank of Japan will act on its 2.7% inflation forecast could lead to a significant strengthening of the yen, potentially overshadowing the weak manufacturing data. Create your live VT Markets account and start trading now.

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