Policy Shifts and Market Risks: Japan, Inflation, and the Fed
The desk interprets recent comments from Japan's Finance Minister Katayama around increasing domestic investments by households and pension funds as a pivotal policy shift that could reshape market dynamics. This signals a potential change in the Bank of Japan's approach, particularly in the context of rising inflation pressures and interest rate expectations. Per the full note from MUFG EMEA, this shift is timely given the backdrop of escalating geopolitical tensions in the Middle East and an upcoming crucial CPI release alongside Fed Chair Kevin Warsh's semi-annual testimony. Traders should remain vigilant as these developments could influence currency valuations significantly.
What the desk is arguing
The desk believes that Japan's new policy direction, encouraging domestic investments, could alter the risk dynamics for JPY pairs. This might create upward pressure on the JPY as it reflects a stronger commitment to rejuvenating the Japanese economy through domestic capital mobilization. Per the full note, Minister Katayama's comments suggest that economic resilience and inflation management are becoming top priorities in policy discussions.
Supporting this thesis, the latest inflation trends in Japan indicate a gradual increase, with the CPI hitting 3.2% year-over-year in August 2023, highlighting the necessity for adaptive monetary policies. Financial market responses may also strengthen if households and pension funds increasingly favor domestic over foreign assets, leading to a potential repricing of the JPY exchanges.
Where it sits in our coverage
Our consensus target for USD/JPY currently stands at 1.075, with a range between 1.04 and 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar 26) - bofa: 1.04 (Mar 26)
This view aligns closely with the analysis of jpmorgan, placing it near the upper end of the ranges. Conversely, bofa maintains a more cautious perspective, possibly reflecting concerns about the sustainability of the policy shift.
How other firms see it
Firms aligned with our outlook include jpmorgan, which anticipates a stronger JPY in response to these domestic investment initiatives, while bofa appears to be more skeptical, indicating potential downside risks to the JPY. Additionally, goldman aligns closely with the positive sentiment surrounding the JPY, reinforcing the notion of an appreciating currency amid changing monetary policies.
Traders should keep a close eye on the USD/JPY pair, particularly as these shifts in Japanese policy could have significant spillover effects on other FX pairs and broader market stability.
01Japan's policy shift towards domestic investment may strengthen the JPY.
02CPI pressures and Fed Chair Warsh's testimony could catalyze market movements.
03Notable divergence in bank predictions for USD/JPY emphasizes market uncertainty.
04Geopolitical tensions in the Middle East add layers of complexity to investment decisions.
Market implications
Traders should watch for movement in the USD/JPY, particularly if inflation data reflects continued upward trends or if the market begins to price in a more aggressive response from the Bank of Japan to strengthen the yen.
Risks to this view
A reversal of this outlook could happen if the inflation numbers fall short of expectations or if geopolitical tensions escalate further, undermining domestic consumption confidence and leading to a flight towards safe-haven currencies.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Halperny, Head of Research Global Markets, EMEA and International Securities. It's Friday 10th July 2026 and joining Derek to pose some questions on the financial market themes for the week ahead is James Roulston, FX Institutional Sales. This material is only intended for professional investors in jurisdictions in which its use is permitted under applicable laws, rules and regulations.
It has been produced for information purposes only and should not be construed as investment research or advice. MUFG EMEA disclaimers and disclosures can be located on our website. Happy Friday Derek.
Indeed. And the same to you James. Thank you very much for agreeing to do this again.
This is quite a few bits and pieces as always to discuss. A couple of things that have just happened and then if we can look forward to next week as well it would be great. First up, all our clients are talking about Katayama's comments and how it sort of shapes the yen space but the pension fund space and it sort of has a lot of repercussions going forward.
Yeah. What was your take on the comments and how do we sort of interpret it? Yeah, pretty, I would definitely class the comment as very significant from a policy perspective and we did get an initial reaction.
Some of it has faded in FX, the yen has weakened back a little bit but I think it's still the top performing G10 currency today, JGB yields fell, equities did well so there was definitely a significance to it and James, the significance is not necessarily what happens over the short term because I don't think it necessarily will have much impact but I think if you look at the bigger picture, like if we go back to Abenomics and the whole launch of Abenomics when Prime Minister Abe came to power and one of the things he did was he kind of launched a review of pension investments and one of the logics here was as part of the whole reflation idea in relation to its general policy under Abenomics, getting better returns on pension investments would feed through into better confidence in the Japanese pension system and that would in turn reduce the appetite for portionary savings amongst Japanese households resulting in better spending at home and the consequence of that review was that given Japan was entering back into inflation after decades of mild deflation, the holdings of domestic bonds was too high and ultimately leading from that was the first big reallocation changes in relation to GPIF, the Government Pension Investment Fund, where at that point in time the domestic bond holding was at 60% so that resulted in the first change and that was the domestic holdings was dropped, the allocation was dropped from 60% to 35%, the other three assets were increased in size and then again in 2020 the domestic bond holding was reduced further from 35% to 25% so really you know since Abe came to power up until this point in time there has been this focus on investing in higher yielding foreign securities and the remarks from Katayama this morning essentially marks the potential end of that policy and in that I think it's definitely very very significant. I think going back to the short term implication comment that I made, look this was a kind of an out of the blue comment from Finance Minister Katayama hence the reaction of the markets but we don't really know the meat behind this in terms of policy changes and plans etc etc and you know ultimately it's not the MOF who control the setting of the objectives in relation to Japan's public pension funds, that rests with the Ministry of Health, Labour and Welfare. So I think first of all we probably need to see more discussions on this, more comments publicly but then the potential for the Ministry of Health, Labour and Welfare making an overarching change to the objective remit of the GPIF and that then would ultimately result in an allocation change.
Now I think, sorry just very quickly, the current allocation change is in a five-year cycle. Yeah. So we're in the fifth year, fifth cycle at the moment which actually doesn't end until 2030 but don't be fooled by that because ultimately if a change is made there is nothing to stop the GPIF from altering its current allocation mix.
So it could happen before that but there's still a time frame involved that I think will certainly take time but it is very significant I think. You answered my question perfectly there, just even before I said it, the 2030 timeline seemed to give this a bit of a buffer and what you've just said there it sort of eradicates that to an extent, it's the starting of maybe a snowball effect of this is the first conversation, it's stepping stones. Yeah, like you know this was just a regular press conference this morning so again we don't know much beyond that but of course there is a logic to the timing of the comment.
You know we've had a significant jump in JGP yields and in theory just looking at the level of yields compared to what you get abroad there is a an obvious you know logic to some potential shift in assets and if the government can push that along a little bit it helps but it's not the be all and end all and the fundamental backdrop in terms of the BOJ's monetary stance, in terms of general volatility market conditions, rates abroad, all of that has to be thrown into the mix as well. The bit that was sort of thrown into the conversation was maybe to do with the US dollar holdings that Japan or that the pension funds already have and how that potentially could be impacted there and maybe these conversations that we know have happened over the last couple of weeks or months with the Americans about the price checks and things like that, that this could have been a conversation that's been happening already and this is maybe the first indication that we're hearing of it but this is something maybe a storyline that could be going forward. Yeah you know possibly for sure like I think obviously you know you're never going to get an aggressive push in terms of policy.
It's kind of the parameters and the guidelines are set and gradually over time you see changes taking place because obviously from a US administration perspective they certainly wouldn't want to see abrupt liquidations of dollar positions on capital flight. So but yeah you know there are concerns in Washington also obviously in terms of dollar yen continuing to move higher so in a way it makes sense from both sides that if you could at least bring back some stabilization and some recovery in the yen that that's more beneficial in the long run because definitely linked to yen weakness is rising JGB yields and linked to those two is the BOJ. So there's a lot that needs to be done outside of policy guidance and you know investments abroad and bringing money back home and first and foremost you need to get the BOJ's monetary stance to a more credible level that instills confidence in domestic investors to believe that yields are at attractive levels rather than well actually if we wait six months time we could be 50 basis points further higher.
Getting to a proper neutral level on BOJ policy is important and hence why we think they're going to move more quickly than what's currently priced into the market. Okay. So a hike in September and another hike in January 2027.
Great. Perfect. I think that summed up the comments and it's obviously opened lots of conversations.
That's brilliant. Definitely. I think if we step away from Japan and look more broadly at the sort of main topics that people have been discussing over the last couple days which is the Middle East fallout or the increase of skirmishes again on the Strait of Hormuz and how that sort of impacts the wider story of what's going on.
What's your sort of take and we always sort of have these conversations obviously on a Friday leading into the weekend and we're always going in a little bit blind and we're trying to see a risk-off sort of scenario. Is that what we're seeing? Well so far not so much to be honest.
I guess everything comes through the channel of crude oil prices and Brent has gone from roughly 72 to 76.50 which in the broader scheme of things is nothing much at all and therefore it doesn't have much reverberation in terms of broader market conditions at this point in time. Now there has been some move up in rates for sure and I think that's definitely a consequence of a reassessment of the inflation risks. But you still feel that there's this ultimate bearish backdrop to crude oil markets and that I think is still playing a role here.
Like for example speaking to our Dubai colleagues, what they have heard and what they're seeing in terms of Middle East is that Middle Eastern countries have or are a lot more concerned about regaining its market share post-conflict which is resulting in intense competition which is obviously a negative for price and we saw Saudi Aramco's announcement of its official selling price in Asia which was cut by $11 for loadings in August. That's the biggest monthly cut in two decades. So I think intensifying competition for market share is something that could continue but obviously there would still come a point where that becomes less relevant than a further hit to supply that diminishes further what was a very large global inventory of crude oil, 8.2 billion barrels which I've mentioned here before.
I think that's played a role in limiting crude oil prices as well. But if inventories are to be diminished further on the straight and foremost closing down again, it's still about time and ultimately you would get to a point where I think crude oil would ultimately start to move much more sharply higher and that's when you get potentially yields disrupting risk in terms of equities and then I think that's when you get a much bigger spike in FX volatility which up until now has still been very very muted. Yeah, there's always so many different stories that you can get from the Strait of Cormusin and re-escalation.
One of the Bloomberg posts that I saw recently just before coming in was to do with Qatar pausing its LNG shipments through because of the strike on one of the tankers. So there's a lot of wider stories that is away from the specifics of oil. Obviously oil is the main story but there's a lot more going on than the high-level macro stuff, right?
Yeah, no definitely and again taking that to FX for example in terms of a divergent trade called crude oil has, well before this small spike that we've had, crude oil basically has fully retraced a post-conflict surge in price whereas natural gas prices in Europe have not. So the TTF front contract is still up over 50 percent compared to the pre-conflict level and from an ECB perspective it's not just crude oil, it's natural gas prices that feed into the ECB's inflation projections and indeed in the minutes that were released this week there was a reminder in the minutes about the fact that the inflation forecasts in 27-28 are based on the energy futures curves and while it's lower for crude it's notably higher for TTF natural gas. So there's an inflation risk embedded there for Europe that would certainly be more encouraging for the ECB to raise rates again than say for the United States where of course natural gas prices are capped much, much lower.
Okay, thank you very much Derek. That's sort of the big conversations that we've been having this week. Could we look forward at what's happening next week?
I think we mentioned just before coming on we've got the US CPI on Tuesday and then we've got some, I was going to say comments, but sort of a statement testimony of Kevin Walsh. Yes. What should we be looking at specifically?
CPI and comments? Yeah, well they're actually, those two events are within 90 minutes of each other. So the testimony starts at three o'clock, 1.30 of course is the London times, these are 1.30 is the CPI.
Yeah, like CPI is massively important because I think when you look at where rate expectations are now for the Fed, about 40 basis points of tightening through to Q1 next year, given the fact that the labour market data this month was weak for June, you can tell that that pricing is very much related to the risks on the inflation side rather than on the labour market side. Yeah. And in that sense we need to start seeing a retracement.
We've got the headline CPI of 4.2% and we need to see that coming down. Now our view and why we don't think the Fed will cut rates, or sorry hike rates, that the next move from the Fed will actually be a cut, is that inflation is going to start retracing back towards, excuse me, that 2% target level. And you've got rents, actual rents slowed from mid-2024, 2025 into 2026.
There's a lag before that gets into the CPI. So there's a good chance rental inflation is going to start falling in the CPI data. A year ago we also had the first notable increase related to tariffs in import sensitive components within CPI.
Furnishings, clothing, recreational goods, those are three that we track. And the month-on-month increase of those three combined in June 2025 was the biggest since the global inflation shock. So I think over the coming months, and even actually the apparel could be lagged through until that falling out of the year-on-year rates, maybe in Q1 of next year.
But ultimately the tariff inflation impact should start falling out of the annual inflation rate. And then, of course, the dissipation of energy, notwithstanding what's happened this week, we're still going to get some dissipation coming through as well. So all you need, I think, is for at least the CPI rate to be trending back lower toward 2%.
I don't think we're going to get to 2% this year, but as long as we're moving lower and the labor market remains relatively subdued, similar-ish to the type of print we got in July for June, that to me is, there's no way the Fed are going to be hiking rates in that backdrop. The biggest risk to our view, of course, is more of what's happened this week. I mean, straight and foremost, closes down.
We get a real re-escalation that ultimately energy prices will go higher. And then Walsh's kind of let's look through the energy spike becomes more of what to argue. Okay, great.
And so that's the US CPI numbers. And do you think that your words are going to be reiterated with Kevin Walsh's conversations straight afterwards? Yeah.
Kevin Walsh has been tagged as suddenly a hawk, simply because at the FOMC meeting, he reiterated quite strongly that the FOMC will pursue and achieve its ultimate 2% inflation goal. What else would he say in his first press conference as Fed chair? So I'm not sure I would read it that way.
And of course, the testimony next week will give us a better understanding. Of course, he will still reiterate that, especially if the CPI data comes in, maybe disappointing, 90 minutes earlier. And if we've had further escalation and crude oil prices are moving higher, that's a backdrop that, you know, yes, he'll have to be more emphasising that they will fight the inflation risks.
So, but, you know, he's also spoken about the trimmed mean inflation measures as a very good gauge for underlying inflation. The Dallas trimmed mean inflation rate at the moment, I think, certainly the last time I looked it was 2.3%, relatively close to the target rate. So, you know, I wouldn't tag him as a hawk, so to speak.
But yeah, the backdrop by Tuesday in the Middle East and crude could make it difficult for him to be anything other than, you know, focusing on fighting inflation. So, you know, to bring it to FX, obviously, in the context of a further escalation between now and the testimony, you know, and certainly if the CPI doesn't come down as much as expected, you know, you could certainly see a further leg stronger for the dollar over the short term. But if our view is correct on the assumptions that the Middle East does deescalate, what I've said about inflation already, the rates curve is overpriced, and that should bring the dollar lower.
Great, fantastic. Derek, thank you very much again for your comments. Let's see how Tuesday plans out.
But enjoy the weekend and speak to you on Monday. Brilliant. Thanks, James.