- Japan’s real wages rose for a second month, aided by strong winter bonuses
- Unions are pushing for another bumper wage hike in 2025, with March talks in focus
- BoJ rate hike probability by May appears underpriced
- USD/JPY bias bearish given price and momentum signals
Summary
Japan’s economy is holding up well despite the Bank of Japan (BoJ) delivering its largest rate hike in nearly two decades in late January. Private sector activity is strengthening, and there are glimpses of wage pressures, allowing policymakers to continue the process of normalizing monetary policy settings—and perhaps sooner and by more than markets think. As a major funding source for carry trades around the world, that has major implications for the USD/JPY outlook.
Japan’s Economy Looking Good
If the BoJ were looking for reasons to keep lifting rates, policymakers didn’t have to look far on Wednesday.
Private sector activity levels improved in early 2025, with the au Jibun Bank Japan Services PMI lifting to 53.0 in January. A reading above 50 indicates activity strengthened across Japan’s service sector relative to December. The report noted a “steeper and solid rise in new business inflows,” which saw firms “raise employment levels in order to meet business requirements.”
Of importance to Japan’s interest rate outlook, customer prices rose at the fastest clip since May, while input price inflation hit a five-month high.
“Latest data also signalled a sharp increase in average prices charged at the start of 2025,” the report noted. “Charges have now risen in each of the last 33 months.”
Suggesting a virtuous cycle between wage and inflation pressures may be forming, real wages rose 0.6% in December, helped by a surge in winter bonuses, marking the second straight month of gains. Base salaries climbed at the fastest pace in three decades in 2024, while total cash earnings jumped 4.8% year-on-year.
With unions pushing for another bumper pay rise in 2025, all eyes are on Japan’s annual wage negotiations in March. Rengo, the country’s largest union, is demanding at least a 5% increase. Last year’s 5.1% average hike was the largest since the early 1990s.
May Rate Hike Risk Looks Underpriced
For the Bank of Japan, the outcome of these talks will be crucial. Policymakers have made it clear that sustained, broad-based wage growth is a prerequisite for raising interest rates. With early wage surveys from talks looking promising, evidence of another strong increase could pave the way for the BoJ to lift interest rates further—and sooner—than many traders think.
Source: Bloomberg
Swaps markets are not fully priced for another 25bps hike until the BoJ’s September meeting. Curiously, pricing for such an outcome at the bank’s May meeting—which comes after the conclusion of annual wage negotiations—is only 22%. That looks skinny given trends in wages, activity, and inflation. And not just to this scribe.
Hideo Hayakawa, former director of the BoJ, told Bloomberg on Wednesday his base case for rate hikes was that “there is a lot more coming.”
“There is little logical reason to believe that rate hikes will stop early,” he said. “They will get to 1% first.” Hayakawa sees the terminal rate for the bank’s tightening cycle at 1.5%, a full percentage point above its present level.
In the wake of Wednesday’s economic releases and Bloomberg report, Japanese one-year interest rate swaps—which measure the average overnight interest rate expected over the next year—hit highs not seen since the onset of the Global Financial Crisis in 2008.
Source: Refinitiv
US Yield Advantage Dwindles
While Japanese bond yields typically have little to no relationship with USD/JPY moves, it’s a different story for yield differentials between the US and Japan which are often strongly correlated—including now.
2-Year yield spreads between the nations—which are heavily influenced by central bank policy rate expectations—have seen a rolling 20-day correlation coefficient score with USD/JPY of 0.82 over the past month. The relationship has been even stronger with 10-year spreads, scoring 0.88 over the same period.
Source: TradingView
While most of the spread compression and widening is driven by the US interest rate outlook, shifts in Japan’s rate outlook can and do impact USD/JPY significantly on an ultra-short-term basis.
USD/JPY Heavy with Big Tests Below
Zooming out to a weekly timeframe to eliminate distortion from recent trade headlines, USD/JPY sits at an interesting level on the charts, testing support at 153.30. Sitting in a potential falling wedge, rather than breaking higher as convention suggests, it looks at risk of doing the opposite.
Source: TradingView
The price action looks heavy as yield differentials between the US and Japan compress. With RSI (14) rolling over and MACD on track to confirm the bearish signal, the bias is to sell pops and downside breaks.
Below, the 50-week moving average looks important—just look at how many times the pair has interacted with the level since June 2024. So too does 151.95, the 2022 high. It may prove tough for bears to crack these key levels without a major dovish catalyst from the United States, such as a jobs report. January’s nonfarm payrolls report arrives on Friday…
If 151.95 were to buckle, 148.65 and 147.20 would be levels of reference. It’s not the favored outcome, but if the price were to reverse and breakthrough wedge resistance, the bearish bias would be invalidated.