Tokyo CPI a focus as decline in y/y rate expected

JPY risks turning to the upside with US and especially European tightening fully priced

EUR/JPY and GBP/JPY consequently looking toppy

ISM services index should hold steady

Friday sees the final non-manufacturing PMIs and the ISM services PMI, but the data seems unlikely to move the markets much. Perhaps more important could be the Tokyo February CPI data due first thing in Asia. This is a precursor of the national CPI data, and the consensus is that it will show a decline to 3.3% y/y from 4.3% y/y, helping to justify the continuation of loose BoJ monetary policy. But the risks are on the upside, and if we see a more modest decline in the y/y rate, it might re-ignite expectations of BoJ tightening soon after Ueda takes office as the new BoJ governor in April. The release of 3.4% y/y slightly missed consensus but is still a sign of moderation. However, core inflation came in stronger than estimates and warns of more "sustainable" inflation in the loop.

The JPY could therefore be sensitive to the data, even though from a yield spread perspective, it seems unlikely that anything that happens in Japan will be particularly significant, as yields are much more likely to move substantially in the US and Europe. Nevertheless, any suggestion that Japanese yields could match or exceed the rises in US and European yields going forward could be expected to trigger significant JPY gains.

As it stands, we believe the European markets are overpricing the scope for ECB and Bank of England tightening this year, which suggests to us that from a yield spread perspective there is scope for EUR/JPY and GBP/JPY to move lower. The EUR curve is pricing another 160bps of tightening, and the UK curve another 80bps. While an ECB rate hike of 50bps looks very likely in March, it isn’t clear that there will be further subsequent hikes, while the comments from BoE governor Bailey this week suggest that it is far from clear that the BoE will raise rates in March, and three more rate hikes this year looks excessive.

It is less clear that the US markets are overpricing the scope for Fed tightening, as it does seem likely that the FOMC will move the “dots” higher at the March meeting. The December dots were already suggesting a funds rate above 5% at the end of the year, so the 5.5% peak priced in the US market looks reasonable, although there shouldn’t be much scope for a further rise. This suggests to us that there is now more scope for yields to decline in the US and Europe than for yields to rise (particularly in Europe), Thursday’s reported rise in February Eurozone core inflation to 5.6% notwithstanding. EUR/JPY and GBP/JPY therefore look vulnerable here, especially if the Japanese data don’t show the expected inflation decline. 

Of the US data the ISM non-manufacturing survey looks to have the most potential to move markets. We expect February’s ISM services index to see a marginal rise to 55.5 from 55.2. Apart from a weak December 2022 reading of 49.2, which was probably due to bad weather, the index has been in a tight range near 55 since mid-2022. However, it has held up better than the S and P PMI in the last year, so there is some risk that even though the S and P PMI recovered in February, the ISM version is less buoyant. Also, having seen a steady rise in US yields through the week, the risks on Friday may be for some corrective activity, suggests the USD could dip lower into the end of the week.