Tokyo CPI Ex. Food (YoY) (DEC) (23:30 GMT; 18:30 EST)
Expected: 0.3%
Previous: 0.1%

Industrial Prod (MoM) (NOV P) (23:50 GMT; 18:50 EST)
Expected: -1.7%
Previous: 1.7%

What Are The Markets Facing?

Lately, there has been much talk about the potential for stagflation - a period of ultra-slow economic growth and rampant inflation - particularly in the US and in Europe. Indeed, CPI growth has accelerated rapidly around the world amidst surging energy and food prices, while both consumers and businesses alike have started to cut back on spending, much to the detriment of economic expansion. Will Japan be the next region to join the list of those in danger of falling into stagflation? While economic data due out this week may suggest so, it is highly unlikely. Tokyo CPI (excluding fresh food prices) is anticipated to jump 0.3 percent in December from a year earlier, which will mark the fastest pace of growth in nine years. However, much of price gains will be a result of oil costs, as Tokyo CPI excluding fresh food and energy is anticipated to edge up to an unchanged reading from -0.1 percent. Furthermore, with wage growth faltering, which subsequently erodes disposable income and household spending, retailers have little room to pass through the cost increases from food and energy. As a result, the price pressures that may be reflected in the December CPI readings are likely to fall back in coming months. Meanwhile, industrial production is forecasted to plunge 1.7 percent, as businesses reduce output in anticipation of a drop in foreign and domestic demand. Overall, the biggest concern for Japan will likely remain the health of the economy, as deteriorating housing investment, weak consumer spending, and softening business sentiment and capital expenditures make it clear that the Bank of Japan has no room to normalize rates further. In fact, the bank may be more likely to cut rates in the near-term, and disappointing Japanese data this week may only lead this speculation to be exacerbated amongst traders.

Bonds – 10-Year Japanese Government Bonds

Japanese government bonds have fallen back quite a bit and have gone on to range trade in recent days with support at 136.10 and resistance at 136.42. In the near-term, hot Japanese CPI or gains in the Nikkei could weigh JGBs down. On the other hand, tepid inflation figures and weak industrial production could give JGBs a boost through resistance towards 136.88.

FX – USD/JPY

The Japanese yen has gradually weakened against the greenback through December, and the recent push above 114 was quite bullish for the USD/JPY pair. Japanese economic data due out this week will likely prove to be broadly mixed, as Tokyo CPI is forecasted to jump while industrial production is anticipated to falter. However, the inflation data may only be taken with a grain of salt as the overwhelming concern of the Bank of Japan remains the shaky status of the economy. Furthermore, aside from energy and food prices, inflation risks are to the downside as falling wages limit purchasing power and the ability of businesses to pass through higher costs to consumer. With interest rates already at an ultra-low 0.50 percent, the news will do little to support a bid tone for the yen from an interest-rate-differential perspective, and sharp gains in the USD/JPY pair may go on to target the early November highs and Fibonacci resistance at 115.40/70. On the other hand, with few traders in the markets this week, the news may simply go unheard, leaving USD/JPY to drift sideways.

Equities – Nikkei 225 Index

The Nikkei 225 Index has bounced from critical support at the psychologically important 15,000 level, as the softening yen boosted shares of exporters. We said earlier in the week, “If news flow remains thin next week, Japanese equities could benefit and push the Nikkei towards 15,500.” This was indeed the case, but as we get closer to the New Year, the status of the Nikkei may get a bit dicey as the index looks prone to break out. Resistance sits above at 15,775 while support sits below at 15,500, with a push above the former to be bullish for the index in the short to medium term, and a break below the latter likely to be quite bearish for Japanese equities and the carry trade as a whole. Event risk comes in the form of Japanese CPI and industrial production figures. The data is expected to reflect mounting price pressures and declining output by producers, but with the Bank of Japan highly unlikely to consider raising rates anytime soon, equity market traders may pay more attention to the industrial production report. As a result, the upcoming Japanese data may prove bearish for the Nikkei, though a surprisingly optimistic reading could propel the index towards the 15,775 level.

Terri Belkas is a Currency Strategist at FXCM.