The idea that the Fed might not hike rates this year (though the current debate around CPI centres on whether to hike, rather than rate cuts) does not automatically mean the Bank of Japan (BoJ) can afford to delay a rate increase in September or October.
The BoJ’s rationale for hiking rates is fundamentally domestic. According to the BoJ’s own projections, core inflation is set to accelerate well above 2% from September onwards—a domestic trigger entirely independent of the Fed’s actions. Furthermore, if the Fed stays on hold and US yields remain elevated, the yield differential will fail to narrow, leaving downward pressure on the yen intact. Given the transmission mechanism of a weaker yen leading to higher import inflation and, subsequently, heightened concerns at the BoJ over overshooting inflation, the logic might actually work in the opposite direction.
From another angle—one aligned with the fiscal dominance thesis—if the BoJ decides there is no urgency to act, it risks creating a paradoxical outcome: prolonging yen weakness and merely kicking the can down the road regarding unrealised losses on fiscal accounts and insurance balance sheets. While the market has scaled back the probability of a September rate hike, it continues to price in more than one full rate increase by the end of 2026.
Just as political manoeuvring around Kevin Warsh may be distorting the Fed's rate-hiking cycle, the dynamic between a Takaichi administration and the BoJ should perhaps be viewed through a similar lens. Rather than a straightforward correlation where "the BoJ won't move because the Fed isn't moving", it is more accurate to view both central banks as playing out parallel yet independent dramas, each torn between domestic political pressure and local economic data.
Today’s rates have little to do with elevated inflation expectations which are subdued as judged by breakevens, and more to do with future primary surpluses. Expectation of primary surpluses is down which elevates monetary inflation as reflected thru discount factor on existing debt. It shows up in rates decomposition as either real yields or term premium. So market isn’t concerned with inflation yet, it is concerned with fiscal story.
As long as that is the case, rates will be higher and Fed will have to hike accordingly irrespective of inflation. Inflation will be additive to the story once base effects fade into Fall and new price pressures are apparent
The front end is pricing hikes only because of Warsh's aggressive rhetoric guaranteeing the FED will reach its 2% price stability target. He created this "problem", probably due to his effort to gain some credibility with the markets that do view him as a potential finger puppet. And because he didnt tighten, which his rhetoric suggested he would favor, now he is catching flak. What the market appears not to get is Warsh's favorite inflation measure of inflation, the Dallas FED's trimmed mean PCE is already at 2.2%. If the FED "adopts" this measure as its favorite then Warsh has essentially "kept" his promise, and I guess to him, deserves the markets credibility. Lets see what the task force recommends, but the FED changing inflation measures to one more friendly to easier & Trump aligned policy wont be viewed kindly the long end of the bond market, nor gold.
But a growth of unemployment due to use of AI is not so great disinflation. But that possibility strengthens Robin's argument that there is no need for tightening.
The market will do the Fed’s tightening for it. And all those people released from drudgery by AI can find better things to do - like folk leaving the land for the cities in the Industrial Revolution.
The idea that the Fed might not hike rates this year (though the current debate around CPI centres on whether to hike, rather than rate cuts) does not automatically mean the Bank of Japan (BoJ) can afford to delay a rate increase in September or October.
The BoJ’s rationale for hiking rates is fundamentally domestic. According to the BoJ’s own projections, core inflation is set to accelerate well above 2% from September onwards—a domestic trigger entirely independent of the Fed’s actions. Furthermore, if the Fed stays on hold and US yields remain elevated, the yield differential will fail to narrow, leaving downward pressure on the yen intact. Given the transmission mechanism of a weaker yen leading to higher import inflation and, subsequently, heightened concerns at the BoJ over overshooting inflation, the logic might actually work in the opposite direction.
From another angle—one aligned with the fiscal dominance thesis—if the BoJ decides there is no urgency to act, it risks creating a paradoxical outcome: prolonging yen weakness and merely kicking the can down the road regarding unrealised losses on fiscal accounts and insurance balance sheets. While the market has scaled back the probability of a September rate hike, it continues to price in more than one full rate increase by the end of 2026.
Just as political manoeuvring around Kevin Warsh may be distorting the Fed's rate-hiking cycle, the dynamic between a Takaichi administration and the BoJ should perhaps be viewed through a similar lens. Rather than a straightforward correlation where "the BoJ won't move because the Fed isn't moving", it is more accurate to view both central banks as playing out parallel yet independent dramas, each torn between domestic political pressure and local economic data.
Inflation is transitory since 2021… but still well above the target. The FED will slowly but surely lose credibility
Today’s rates have little to do with elevated inflation expectations which are subdued as judged by breakevens, and more to do with future primary surpluses. Expectation of primary surpluses is down which elevates monetary inflation as reflected thru discount factor on existing debt. It shows up in rates decomposition as either real yields or term premium. So market isn’t concerned with inflation yet, it is concerned with fiscal story.
As long as that is the case, rates will be higher and Fed will have to hike accordingly irrespective of inflation. Inflation will be additive to the story once base effects fade into Fall and new price pressures are apparent
The front end is pricing hikes only because of Warsh's aggressive rhetoric guaranteeing the FED will reach its 2% price stability target. He created this "problem", probably due to his effort to gain some credibility with the markets that do view him as a potential finger puppet. And because he didnt tighten, which his rhetoric suggested he would favor, now he is catching flak. What the market appears not to get is Warsh's favorite inflation measure of inflation, the Dallas FED's trimmed mean PCE is already at 2.2%. If the FED "adopts" this measure as its favorite then Warsh has essentially "kept" his promise, and I guess to him, deserves the markets credibility. Lets see what the task force recommends, but the FED changing inflation measures to one more friendly to easier & Trump aligned policy wont be viewed kindly the long end of the bond market, nor gold.
Hi Robin, what could make the market change his mind in your opinion - would neg benchmark revisions be the potential trigger? Thanks Thorsten
Disinflation is good. That’s prices falling for ordinary people. The stock market is the only market where people complain if prices fall.
But a growth of unemployment due to use of AI is not so great disinflation. But that possibility strengthens Robin's argument that there is no need for tightening.
The market will do the Fed’s tightening for it. And all those people released from drudgery by AI can find better things to do - like folk leaving the land for the cities in the Industrial Revolution.