US
USD has stabilized following yesterday’s dip triggered by heightened political threat to the Fed’s independence. Even if checks remain – Republican resistance in the Senate and a non-autocratic FOMC – the politicization of the Fed weakens its inflation-fighting credibility which is a structural drag on USD. In the near-term, the recent upward adjustment to US rate expectations following a run of Goldilocks-type US economic data offers USD support.
Influential New York Fed President John Williams echoed the Fed’s on-hold guidance. Williams stressed that “Monetary policy is now well-positioned to support the stabilization of the labor market and the return of inflation to the FOMC’s longer-run goal of 2%.” Williams’ base case for 2026 is above-trend GDP growth between 2.5%-2.75%, inflation to peak at around 2.75-3.0% “sometime during the first half of this year, before starting to fall back,” and the unemployment rate to stabilize.
Fed funds futures price little chance of a cut at the next three FOMC meetings (January 28, March 18, and April 29). The next full 25bps cut isn’t priced until the June 17 meeting. Non-FOMC voters St. Louis Fed President Alberto Musalem and Richmond Fed President Tom Barkin speak today.
US December CPI is the focus (1:30pm London, 8:30am New York). Headline inflation is expected at 2.7% y/y for a second consecutive month, and core inflation is seen rising 0.1pts to 2.7% y/y. The Cleveland Fed’s Nowcast model forecasts both headline and core CPI at 2.6% y/y in December. The December CPI print should be treated with caution because the missing October price quotes and later-than-usual November price collection have distorted the data.
More importantly, upside risks to prices are fading and leaves scope for the Fed to ease policy. The ISM prices paid indexes point to moderating inflation pressures. Additionally, average hourly earnings growth (3.8% y/y) is running around sustainable rates consistent with the Fed’s 2% inflation goal given annual nonfarm productivity growth of around 2%.
JAPAN
JPY and JGB slide, while the Nikkei rallies as Japan election talks fuel bets of more government stimulus. According to Kyodo News, Japanese Prime Minister Sanae Takaichi plans to announce a dissolution of the lower house of the legislature on January 23, paving the way for a snap election in February.
Takaichi does not need to call a general election until October 2028, but she may want to capitalize on her high approval rating (of nearly 70%) to regain her party’s (LDP) majority in the lower house. That has raised concern over a further loosening of Japan’s fiscal discipline as reflected by the underperformance in JPY and JGBs.
In our view, worries over Japan fiscal profligacy are overdone. Japan nominal GDP growth is running at around 4% and leading indicators point to an encouraging growth outlook, while 10-year government bond yields are closer to 2%. With growth comfortably exceeding borrowing costs, Japan can sustain primary budget deficits without putting its debt ratio on an upward trajectory. In this environment, fiscal sustainability is far less fragile than markets currently imply.
In the meantime, the risk of BOJ intervention to curtail JPY weakness is rising with USD/JPY closing-in on 160.00. Japanese Finance Minister Satsuki Katayama reiterated her “concerns about the one-way weakening of the yen,” adding that “Treasury Secretary Bessent shares those concerns.” The chair of Japan’s biggest business lobby Keidanren also chimed in cautioning that the current yen weakness is a bit excessive and a correction for stronger yen is needed.
In its last two FX interventions, the BOJ bought ¥9.79 trillion from April 26, 2024 through May 29, 2024 after USD/JPY rallied by 5.7% in 20 days to a high of 160.17. And, the BOJ bought ¥5.53 trillion from June 27, 2024 through July 29, 2024 after USD/JPY rallied by 4.2% in 30 days to a high of 161.95.
