JPY rates are buoyant as market participants mull the third BOJ hike of the cycle. The market is pricing in about 40% chance of another 25bps hike in December following the Tokyo CPI beat (2.6% YoY against consensus of 2.2%) that followed on the heels of firm CPI and PPI numbers for October. Inflation expectations (as measured by 5Y breakevens) have also climbed by over 20bps to 1.56% over the past two months as investors figure that the pace of BOJ hike may not be sufficient to rein in inflation. This probably also accounts for why the JGB curve remains the steepest across the G10 space. It is also interesting to note that despite yen strength since mid-November, there has not been a corresponding drop in breakevens. A positive feedback loop arising from a healthier pace of inflation (and wage) expectations and higher rates may have taken hold as the BOJ actively kept the tightening cycle slow. We think JPY rates are biased higher with some room to go before the neutral target rate (estimated to be around 1% for the target rate) gets hit.
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