Tokyo inflation eased in May, with the headline Tokyo CPI rising 1.4% year on year versus 1.5% previously, according to the Statistics Bureau of Japan. The ex-fresh-food measure increased 1.3% YoY, undershooting a 1.5% forecast and slowing from 1.5% in April, while the ex-fresh-food-and-energy gauge rose 1.6% YoY, down from 1.9%. Following the release, USD/JPY was 0.17% lower on the day at 159.25.
Ahead of the print, markets had framed Tokyo CPI as the last major near-term driver for the yen, after reports of two intervention rounds totalling more than $60 billion in late April and early May. USD/JPY had recovered roughly 80% of the post-intervention move and was trading near 159.20, close to 160.00. April’s data had come in at 1.5% YoY for both headline and ex-fresh-food, while the ex-fresh-food-and-energy reading was 1.9% versus a 2.3% consensus and marked the slowest pace since March 2022; it was also a third consecutive month below the Bank of Japan’s 2% target. The funding backdrop referenced a roughly 300 basis point gap between the Fed’s 3.50% to 3.75% target range and the BoJ’s 0.75% policy rate, alongside technical levels including a 50-period EMA near 158.50 and a 200 EMA close to 155.50, with intraday price slipping from 159.65 to around 159.20 pre-release.
Bank Of Japan Policy And Market Dynamics
With the latest Tokyo inflation figures coming in softer than expected at 1.4%, we see little reason for the Bank of Japan to consider a meaningful interest rate hike in June. This reinforces the existing dynamic in the currency markets. The USD/JPY pair is hovering near 159.25, not far from the 160.00 level that has historically triggered official action.
The core of our strategy remains focused on the interest rate differential between the US and Japan, which is currently over 500 basis points. This massive gap makes it profitable to borrow yen and invest in higher-yielding US dollars, a strategy known as the carry trade. As long as this differential persists, the natural path for USD/JPY is upward.
Therefore, we believe any pullbacks in USD/JPY should be viewed as buying opportunities. The market’s conviction is that the Bank of Japan’s rhetoric about policy normalization will not translate into action without a significant and sustained rise in inflation. This leaves the yen vulnerable to further weakness in the coming weeks.
Strategic Positioning And Risks
We must, however, remain vigilant about the risk of currency intervention from the Ministry of Finance. We saw interventions totaling over ¥9 trillion in April and May of 2024 when the dollar-yen rate crossed the 160 threshold. This level remains a clear line in the sand, and we expect verbal warnings to intensify as we approach it again.
For our derivatives positioning, this environment suggests buying call options on USD/JPY to capitalize on the expected upward grind. To manage the risk of a sudden, sharp drop caused by intervention, we can use call spreads to cap both our potential profit and initial cost. We are also preparing to sell puts on any intervention-driven spike lower, viewing it as a chance to re-enter the prevailing trend at a better price.
Looking ahead, the next several weeks will be dictated by inflation data from both Japan and the United States. A surprise to the upside in Japanese wage or inflation data is the only thing that could credibly shift the Bank of Japan’s timeline. Until then, the path of least resistance for USD/JPY remains higher.
