After the US and Japan reaffirmed their currency policies without addressing foreign exchange levels, USD/JPY briefly increased but then fell. At the same time, yields on Japanese government bonds have been rising, especially at the longer end. A Bank of Japan board member acknowledged recent changes in yields but did not find them unusual. The Bank is cutting its Japanese government bond purchases by about ¥400 billion every quarter, with a review scheduled for June 2025.

Japan’s Economic Data

Recent economic data shows that Japan’s private sector shrank in May. The composite PMI fell to 49.8, the services PMI decreased to 50.8, and manufacturing PMI slightly rose to 49.0. Despite the drop in private sector activity, the swaps market expects a 50 basis point increase in BOJ rates to 1.00% within two years. No official recommendations are given, so individuals should research thoroughly before investing. Overall, it’s clear that Japanese policymakers, while hinting at small changes, are not likely to move the currency markets significantly with just their statements. After the joint statement from Tokyo and Washington, which avoided discussing exchange rates, USD/JPY initially rose. However, this increase was short-lived, fading when it became clear there were no direct actions linked to the statement. This reflects a familiar pattern: commitments to existing frameworks, but without new actions. Bond markets are adjusting their expectations. Yields across Japanese bonds, especially longer-term ones, are gradually rising. This is occurring even as the BOJ slowly reduces its support for government debt. The central bank’s decision to cut JGB purchases by about ¥400 billion each quarter—subject to review next year—seems like a cautious move to restore market stability. This approach is less about timing policy changes and more about understanding the system’s ability to handle pressure over time. The rise in yields suggests a preparation for slight policy adjustments rather than a major shift.

Softening Economic Outlook

One BOJ board member noted the rise in domestic yields but quickly added that these changes are not unusual compared to historical data. This is an important point. The BOJ appears to be addressing fears of market dysfunction or reckless selling. However, the broader economy presents challenges. May’s PMI data reveals that Japan’s private sector activity has fallen below the 50.0 mark, which indicates contraction. The services sector is barely above water at 50.8, while manufacturing is still below at 49.0. The composite PMI dropping to 49.8 suggests that consumption and production might weaken further if confidence continues to falter. This situation limits the BOJ’s ability to act decisively on tightening, despite what swaps pricing suggests. Nonetheless, swaps traders have raised their expectations. The market now believes that the BOJ could increase its policy rate to 1.00% within two years, up from 0.50%. This is significant not because it signals immediate action but because traders are looking beyond current weak data to focus on long-term yield pressures and policy normalization. They don’t believe that slow growth will necessarily stop tightening measures. From our perspective, these conditions present opportunities, but only if approached carefully. Forward curves, especially in interest rate derivatives, are indicating a slow but steady policy shift. This implies that near-term rate movements are unlikely to be dramatic, but there could be value in positioning for higher medium- to long-term rates. It’s essential to observe how the BOJ handles its July meeting, focusing on the magnitude and tone of bond purchase adjustments. Additionally, pay close attention to any indications about inflation trends and wage pressures, as these will be crucial for determining when the next rate hike might occur—not just public statements, which are currently cautious. In summary, the contrast between weaker economic data and stronger rate expectations highlights a balancing act in Japanese financials. Entering and exiting these markets requires a clear understanding of central bank intentions and the subtle pricing shifts happening underneath. Create your live VT Markets account and start trading now.

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