Where to focus
The Bank of Japan is widely expected to maintain its benchmark interest rate at 1% during this week's policy meeting. However, market consensus suggests the central bank will employ a hawkish communication strategy to pave the way for future rate hikes. Against a backdrop of persistently high energy costs driven by Middle East tensions, a chronically weak yen, and robust demand fueled by the global artificial intelligence investment boom, inflationary pressures within Japan are continuing to build. Nevertheless, the BOJ is expected to retain flexibility on the timing of a rate increase, preferring to first observe whether rising energy costs will further transmit to the broader economy and price landscape.
Analysts note that BOJ Governor Kazuo Ueda faces a challenging balancing act. He must send a sufficiently hawkish signal to mitigate imported inflation stemming from the yen's sustained depreciation, while simultaneously avoiding a policy tightening that is too rapid, which could create friction with the government's preference for accommodative fiscal policy. Mitsubishi UFJ Morgan Stanley Securities forecasts that the BOJ will maintain its assessment that price risks are tilted to the upside. The base case remains a rate hike to 1.25% in December, but if the yen continues to weaken and inflation risks escalate further, action could be taken as early as September or October. This meeting also marks the first policy gathering for new board member Ayano Sato. Market attention will be heavily focused on the BOJ's latest quarterly economic outlook and Governor Ueda's post-meeting press conference for further clues on the future policy path.
Sources indicate the BOJ is likely to raise its growth forecast for fiscal 2026, citing an easing of concerns that the Middle East conflict would severely impact the economy. Meanwhile, inflation forecasts may be slightly trimmed due to government subsidies and lower oil prices compared to April. However, the downward revision is expected to be limited as oil price volatility and the weak yen continue to push up import costs. With the short-term inflationary shock from oil prices appearing to moderate, the BOJ is expected to view both downside risks to growth and upside risks to inflation as having diminished compared to three months ago, but it will still maintain a warning that inflation could exceed its 2% target. A growing number of companies have announced plans to raise prices for food and daily necessities in the coming months, and inflation expectations among both businesses and households continue to rise. In April, the BOJ projected fiscal 2026 economic growth of 0.5% and a core consumer inflation rate of 2.8%. The factors supporting further rate hikes are steadily accumulating. Minutes from the June policy meeting revealed that some hawkish board members had already advocated for a faster pace of tightening to gradually bring the policy rate back to a neutral level. The BOJ's latest "Tankan" survey shows that corporate inflation expectations have risen to a record high, and regional economic reports indicate that the Middle East conflict is prompting more businesses to plan price increases later this year. Concurrently, the yen's persistent position near 40-year lows is further inflating import costs. Analysts believe that consumer price data released in the coming months will be the key determinant for when the BOJ will initiate its next rate hike. A Reuters poll currently shows that most economists still expect the BOJ to raise rates to 1.25% by the year-end, with October being the earliest possible timing.
Why focus on just these key points?
The US trade deficit in goods narrowed in June, but the improvement was below market expectations, suggesting that trade may continue to drag on US economic growth for a second consecutive quarter. Data from the Commerce Department showed the goods trade deficit shrank by 4.2% to $101.5 billion in June, slightly wider than the $100 billion economists had predicted. The narrowing was primarily driven by a decline in imports. Imports of goods fell by $8.2 billion to $306.2 billion, although demand for equipment and related products remained high due to the ongoing boom in artificial intelligence infrastructure construction. Meanwhile, exports of goods decreased by $3.8 billion to $204.7 billion, partially offsetting the improvement from the import decline. The US government is set to release its advance estimate for second-quarter GDP this week. The market broadly expects the US economy to have grown at an annualized rate of 2.1% in the second quarter, unchanged from the first quarter. While business equipment investment, particularly AI-related capital expenditure, is expected to remain a significant support for economic growth, trade's drag on growth for two straight quarters also reflects persistently weak external demand.
The bar for a rate hike by the Federal Reserve this week remains high, with the market more focused on whether this signals the start of a new tightening cycle. Although the interest rate futures market has increased the probability of a rate hike this week, most analysts believe the threshold for an immediate move remains elevated. The federal funds rate has been held in the 3.50%-3.75% range since last December. Rising energy prices and hawkish comments from some officials recently drove bets that the Fed might resume hiking this week. However, several former officials and economists point out that the Fed rarely makes a one-off rate adjustment. Historically, resuming rate hikes after a prolonged pause usually signals a series of subsequent policy moves. Therefore, policymakers must decide whether they are willing to signal the start of a new tightening cycle to the market, a step the committee may not be ready to take. The case for an immediate rate hike has weakened since the June meeting. US consumer prices rose 3.5% year-on-year in June, a significant deceleration from the 4.2% reading in May. Core inflation also fell to 2.6% from 2.9%, reflecting that lower energy prices and a temporary easing of US-Iran tensions reduced some inflationary pressure. At the same time, the labor market remains robust. Nonfarm payrolls increased by 57,000 in June, above the level needed to maintain a stable job market. The unemployment rate fell to 4.2%, and wage growth held steady at 3.5%, showing no signs of wage-driven inflation worsening. Nonetheless, the Fed remains highly vigilant about inflation risks. Inflation has been above the 2% target for over five years, re-accelerated in the first half of this year, and renewed tensions in the Middle East causing an oil price rebound have rekindled imported inflation risks. Some policymakers worry that rising energy costs are gradually spreading to a broader range of goods and services, which, combined with demand growth from AI investment, could make price pressures persistent. The market widely expects the Fed to hold rates steady at this meeting, but one to three committee members might vote for an immediate hike, potentially signaling the start of a new tightening cycle in September. Capital Economics expects September to remain the base case for the first rate hike, by which time the Fed will have more evidence on whether goods price pressures are sustained. In contrast, Wrightson ICAP believes that under Chair John Williams, who places a high priority on controlling inflation, the probability of a direct 25-basis-point hike this week is slightly higher than the probability of holding rates steady. Historical precedent shows that a single, isolated rate hike by the Fed is extremely rare. The market's real focus is not on whether the Fed acts this week, but on whether it is prepared to formally begin a new tightening cycle that would last for several meetings.
The US bond market is adopting a cautious stance ahead of the Fed's policy meeting this week. The uncertain policy outlook is preventing investors from making aggressive bets. Most investors are choosing to maintain neutral positions and avoid large directional wagers. While the market broadly expects the Fed to keep rates in the 3.50%-3.75% range, rising energy prices and renewed inflation concerns have once again clouded the future policy path. Investment institutions generally believe there is insufficient reason to increase duration or take on more credit risk at this point. Therefore, they prefer to maintain ample liquidity and wait for inflation and employment data to be released in the coming months for clearer policy direction. JPMorgan's latest Treasury client survey shows that long, short, and neutral positions have changed little from the previous week, with overall positioning near the average of the past four weeks. BNY Mellon suggests that this is not a suitable time for large directional bets on rates and that smaller positions with strict risk control are more appropriate. Although the long-term view remains that rates will rise, the recent increase in energy prices has made the policy outlook more complex than it was a few weeks ago, making aggressive trading around this meeting inadvisable. Market expectations have shifted from betting on two or three rate cuts at the start of the year to now pricing in future rate hikes. CME FedWatch data shows that the probability of a rate hike this week has risen to 36% from 16% a week ago, and the market simultaneously expects a cumulative total of about 43 basis points of tightening by the end of 2026. However, Schroders believes that the meeting itself is not the focal point; what is truly worth watching is whether the bar for future Fed action is being raised or lowered. Some institutions still do not believe the Fed will ultimately resume rate hikes. AllianceBernstein points out that recent inflation has moderated, employment is stable, and the rise in energy prices is a supply-side shock that monetary policy cannot directly address, making further tightening less necessary. At the same time, the recent rise in Treasury yields reflects market optimism about economic growth and the AI investment outlook, rather than a deterioration in long-term inflation expectations. In terms of asset allocation, several institutions are leaning towards maintaining high-quality fixed-income investments, reducing corporate credit exposure, and increasing allocations to securitized assets, mortgages, and some municipal bonds. They also show a preference for short-to-intermediate-term US Treasuries over long-term bonds. With corporate credit spreads near historical highs, investors generally believe the current environment calls for a reliance on security selection rather than significantly increasing overall risk exposure.
On Wednesday, July 29, 2026, no major economic data is scheduled for release in Japan. Market focus will be squarely on the Federal Reserve's federal funds rate decision, the FOMC policy statement, and the subsequent press conference, all due shortly after 2:00 AM Beijing time on Thursday.
Market Updates
The Japanese yen traded nearly flat at 163.77 per dollar on Tuesday, hovering near its 40-year low. The market is intensely focused on whether the Ministry of Finance will intervene again, with traders describing the current situation as a "high-stakes game of chicken with the Ministry of Finance." The MOF intervened in April and May when the yen broke through the 160 level, but failed to reverse the overall downtrend. Finance Minister Satsuki Katayama, in a Reuters interview on Tuesday, reiterated that the government is "always ready to respond to currency moves when necessary" and expressed confidence that the US shares this view. She cited the US Treasury's semi-annual currency report from last week, noting that the US had stated excessive yen volatility is undesirable. When asked about the possibility of a joint US-Japan yen-buying operation, Katayama declined to comment. She also acknowledged that the weak yen has both advantages and disadvantages for the economy. Meanwhile, Katayama described the relationship between the government and the BOJ as "normal and smooth," dismissing market concerns that the government was attempting to interfere with monetary policy. Earlier this month, a draft economic blueprint from dovish Prime Minister Sanae Takaichi urged the central bank to cooperate more closely with the government's growth efforts, unsettling investors. The final version included a footnote safeguarding the central bank's legal independence. Katayama explained that the original wording was not intended to pressure the BOJ, but was a result of the drafters' lack of experience in relevant legal deliberations. On fiscal policy, Katayama emphasized the need to strengthen communication with the bond market to ensure trust, stating that the government will "continuously communicate with the market throughout the process" regarding budget preparations, rather than waiting until the draft is complete in December to announce conclusions. She did not set an annual debt issuance cap but promised to keep issuance within a reasonable range. Responding to recent calls for the Government Pension Investment Fund to invest more in domestic assets, Katayama stated that the fund has established asset management rules and any changes to its portfolio would require following the proper procedures. Global investors are now waiting for the Fed's policy decision on Wednesday, with market expectations including the possibility of a rate hike, which would further impact the yen's trajectory.
Political Landscape
Senior LDP officials are engaged in intensive coordination regarding consumption tax cuts and the stockpile rice policy. Prime Minister Sanae Takaichi held a meeting on the 28th at party headquarters with Vice President Taro Aso and Secretary-General Shunichi Suzuki, expected to exchange views on issues including reducing the consumption tax on food and beverages. At a previous senior-level meeting, Takaichi emphasized that discussions of the Council on Social Security are nearing their conclusion, stating she would "make a decision when one is needed." Secretary-General Suzuki declined to provide details of the meeting's content in a post-meeting press conference, only saying that "thoughts were shared." Intra-party discussions will continue to be consolidated under the leadership of Policy Research Council Chairman Takayuki Kobayashi. On the same day, the Ministry of Agriculture, Forestry and Fisheries formally decided to abandon plans to repurchase stockpile rice released in 2025 ahead of schedule. The decision on repurchase will be postponed until after the autumn, taking into account factors such as the harvest of 2026 crop rice to be released at the end of August. Agriculture Minister Norikazu Suzuki had initially explored launching a repurchase by late July, but coordination proved difficult due to concerns within the government that it would curb the decline in rice prices and contradict measures to combat soaring prices. Data released simultaneously showed that private-sector rice inventories reached a record high of 2.43 million tons at the end of June, well above the reasonable range of 1.8 to 2.0 million tons. The oversupply is primarily due to a significant increase in 2025 rice production and record-high private imports crowding out demand for domestic rice, putting rice prices under accelerating downward pressure.
Financial Markets
On July 28, the Tokyo stock market's Nikkei index fell sharply, closing at 62,364.92 points, falling below the 63,000-point threshold for the first time in about two months. The index plunged 2,566.27 points, or 3.95%, from the previous trading day. Influenced by weakness in US semiconductor stocks, AI and semiconductor-related sectors led the market decline. Since hitting a record closing high of 72,366.34 points on June 25, the index has now lost over 10,000 points in just over a month. The broader TOPIX index fell 102.48 points, or 2.52%, to close at 3,963.59 points. Total trading volume for the day was 2.59337 billion shares. In US markets on the 27th, reports emerged that semiconductor giant NVIDIA was discussing providing a massive credit guarantee for OpenAI's data center plan, fueling concerns about its financial health and causing its stock to fall. This trend spilled over into the Tokyo market, leading to a sell-off in semiconductor-related stocks, which had been leading the rally. Kioxia Holdings hit its daily limit down. The decline in the South Korean stock market, which has a large weighting in semiconductor stocks, also weighed on Tokyo equities. Maki Sawada, a strategist at Nomura Securities, commented, "The market had been positively evaluating AI-related capital expenditure, but considering the impact on financial soundness, market views have generally become more cautious."
Geopolitical Tensions
Saudi Arabia stated on Tuesday that its air defense forces intercepted and destroyed several drones launched from Iraqi territory that were attempting to attack oil facilities in its eastern province. This is the second such attack in less than two days. Saudi Defense Ministry spokesman Turki al-Maliki accused the drones of being launched by Iran-backed militias, emphasizing that Saudi Arabia reserves the right to respond at "appropriate time and place." On the same day, Iranian Foreign Minister Abbas Araghchi held phone calls with his Saudi and Omani counterparts to discuss security in the Strait of Hormuz, stressing the need to strengthen cooperation and advance joint diplomatic efforts to establish regional stability. Oman has submitted a plan for managing the Strait of Hormuz, supported by Gulf states, which proposes collecting voluntary fees for using the strait. The plan aims to lay the groundwork for ending trade disruptions caused by the US-Iran war. The system is similar to the Malacca Strait model, where Indonesia, Malaysia, and Singapore request voluntary contributions from ships for navigation, environmental protection, and search and rescue. However, a US official on Tuesday again rejected the idea of fees, reiterating that the Strait of Hormuz is an international waterway and should not be controlled or restricted by Iran. President Donald Trump over the weekend called off a two-week bombing campaign against Iran, stating that US-Iran negotiations were ongoing, but threatened to resume airstrikes if talks did not progress. Iran has denied seeking to resume talks with the US. Earlier, Iran had blocked the strait following US and Israeli attacks. A partial reopening agreement was reached last month, but the deal collapsed in early July after Iran opened fire on vessels in an unauthorized lane. Before his meeting with Israeli Prime Minister Benjamin Netanyahu, Trump complained about information leaks, but later described the dialogue as "very good." Trump expressed displeasure before meeting Netanyahu at the White House on Tuesday, complaining that details of Netanyahu's plan to discuss Iran's "Mount Gohar" nuclear facility had been leaked to the public beforehand. Using Netanyahu's nickname, Trump said, "I don't need Bibi to tell me this... Why don't you just tell me directly? Why announce it to the whole world?" However, after the meeting, Netanyahu called the conversation "very good," one of their "best conversations," emphasizing that both sides had reached a consensus on ensuring Iran does not acquire nuclear weapons. Trump also met with Ukrainian President Volodymyr Zelenskyy on the same day, after which Zelenskyy stated that strengthening diplomatic efforts to end the war was crucial. The White House described both meetings as "positive and productive." Ukraine's Foreign Minister Andrii Sybiha called his Iranian counterpart on Tuesday, warning against escalation and demanding Iran cease all support for Russia. This followed an Iranian accusation that Ukraine attacked an Iranian merchant ship in the Caspian Sea, causing one death and one injury. Araghchi confirmed that Sybiha indicated the attack was not intentional and that Kyiv does not seek escalation, but stressed that any attack on Iranian citizens or interests is unacceptable and compensation for damages is required. Sybiha stated that Ukraine's actions are "entirely for defending the nation against Russian aggression" and have never targeted civilian vessels or personnel. Meanwhile, Israeli Foreign Minister Gideon Sa'ar also spoke with Sybiha, discussing common challenges including the Iranian threat, and expressed a desire to deepen cooperation with Ukraine.
Technical Strategy
The USDJPY pair is expected to trade within the 164.00 to 163.30 range for the day. From a technical indicator perspective, the 4-hourly Bollinger Band upper band entry point points to the 163.90 area, providing short-term dynamic resistance. The Bollinger Band middle band, currently at 163.75, defines the potential boundary for strength and weakness. The lower band entry point points to the 163.55 area, providing short-term dynamic support. The current exchange rate is trading below the middle Bollinger Band, suggesting that bearish momentum holds a relative advantage. The Bollinger Bands are showing a narrowing pattern, indicating that short-term volatility is decreasing. Concurrently, the 14-period RSI on the 4-hourly chart is in a relatively strong zone around 56.60, indicating that current bullish momentum is solid and the pair still has upward potential. On the 4-hourly chart, the short-term resistance for USDJPY is built around the 164.00 area. If the pair can break above this level during the day, it could potentially challenge the 164.50 area. Looking at the downside structure, short-term support is established around the 163.30 area. If the pair loses this defense line during the day, it faces the risk of a decline to test the 162.65 area. Overall, the short-term market sentiment is leaning towards "caution." If the pair can break through the 164.00 area during the day, it could ignite short-term bullish sentiment, providing confidence for the pair to challenge the 164.50 area. However, a loss of the 163.30 defense line could drive short-term bearish sentiment, increasing the risk of a decline towards the 162.65 area.
USDJPY short-term trajectory reference: Upward: 164.00-164.50 Downward: 163.30-162.65
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