Asia overnight
At the time of writing, Asian bourses were trading mixed and S&P500 futures modestly in the green. Risk-off trading led to JPY outperformance among the G10, while the tariff news led to the CAD being the worst performer with the USD not far behind.
Auto tariffs stick USD/JPY in neutral before US & Japan inflation data
US President Donald Trump’s auto tariffs announcement have so far weighed modestly on USD/JPY. Investors interpret US auto tariffs as an act of self-harm. While Japanese automaker share prices have fallen, so too have those of US automakers. There are two reasons for this dynamic. First, while Japanese carmakers with plants in Mexico and Canada sell most of their cars and car parts in the US, they are already shifting more production to the US to avoid tariffs.
This shift increases their costs of production and crimps their profit margins, which will hurt Japan’s GDP growth and make the BoJ a bit more hesitant to raise rates. But Japanese carmakers have far larger cash reserves than US auto companies to invest in the upgrading of plants and product development as well as to deal with the changing environment. Second, US automakers also import completed cars and car parts from plants in Canada and Mexico and so will have their profit margins squeezed as well, as they are forced to shift more production to the US.
We continue to think the main impact of tariffs on USD/JPY will be their effect on global risk sentiment and the demand for JPY-funded carry trades and on this front, while global equities are a strong driver of the exchange rate, the US-Japan short- term interest rate differential is stronger. Friday will be important for USD/JPY with the release of Tokyo inflation and US core PCE data. Tokyo CPI data is a key leading indicator for the nationwide inflation data released in a few weeks. While the market expects headline inflation to decelerate to 2.7% YoY from 2.9% YoY, the core and core-core measures of Tokyo inflation are expected to stay 2.2% YoY and 1.9% YoY.
Japan’s rates market is already almost fully priced for another BoJ rate hike by July following a strong first tally of spring wage negotiations, so downside surprises in the Tokyo inflation data would lead to a larger move in USD/JPY. Our US economist looks for US core PCE inflation to tick back up to 2.7% YoY from 2.6% YoY.
We continue to think the US rates market remains too aggressively priced for Fed rate cuts given US inflation will remain sticky to the upside and remain long the USD vs JPY and