USD/JPY reverts to 114.00 as attention shifts from Japan election to state-side risk events

During Monday’s Asia Pacific session, USD/JPY hit its highest level in about one and a half weeks at just below 114.50, meaning it only came within about 20 pips of the annual high printed roughly two weeks ago around 114.70. During European and US trade, however, the pair has eased back and is currently flirting with the 114.00 level, meaning it currently trades, leaving it roughly at the midpoint of its 113.20s-114.70ish range over the last two/three weeks.

Surprise LDP majority

The big news out of Japan from the last few days has been the result of the general election held on Sunday; Prime Minister Kishida’s LDP party did better than feared and, against expectations, managed to hold onto a majority in the lower house of parliament, albeit with fewer seats than held in the term that just ended. The news has eased fears that Kishida was on course for a short stint as PM, as had been the case for his predecessor Yoshida Suga, and keeps the prospect of further fiscal stimulus before the end of the year on the table. Thus, Japanese stocks saw substantial gains on Monday, with the Nikkei 225 gaining north of 2.5% on the session – according to some traders, the risk on tone to the Japanese trading session, which also seemed to have a positive spillover effect on global risk appetite, was touted as weighing on the Japanese yen early on Monday.

Focus shifts to state-side events

With the election out of the way, focus in Japanese markets and for the Japanese yen returns to global dynamics. The most important calendar events this week will be the upcoming Fed and BoE meetings, as well as US jobs and ISM Services data. Monday saw the release of the October US ISM Manufacturing PMI survey did not have much impact on FX markets (including on USD/JPY). But the survey did add allude to current economic themes in the US, such as that economic growth, though slower, remains robust, as does demand, but that supply bottlenecks continue to hold back economic activity by slowing manufacturing output, while input costs remain sharply elevated.

Watch yield developments

As has been the case more often than not in recent months, USD/JPY is likely to follow developments in US bond markets, particularly any shifts in the US/Japan 10-year yield differentials. The US 10-year fell back below 1.60% last week and has since struggled to regain ground as inflation expectations pullback from recent highs; 10-year breakevens are back to just above 2.50% having been close to 2.70% at the start of last week. But US real yields have been picking up in recent days, which has mostly offset the drop in inflation expectations, with the US 10-year TIPS yield now at around -0.95% having been as low as -1.15% just four sessions ago. If hawkish FOMC vibes and strong US data this week can support further upside in the TIPS without resulting in too much downside for inflation expectations, then this should push nominal 10-year yields higher again, perhaps back towards recent highs around 1.70%, which would likely be enough to push USD/JPY back towards recent highs in the upper 114.00s.