Insights 
VT 
Japan’s factory activity decreased in July, with the S&P Global Manufacturing PMI dropping to 48.9 from June’s 50.1, indicating a shift back to decline after a temporary stabilisation. This final figure was almost the same as the preliminary estimate of 48.8.
The decline was driven by weaker domestic and external demand, leading to a sharp drop in output—the fastest since March. New orders continued to fall, although the decline was less severe. Employment increased, but at a slower rate, marking a three-month low. Input cost inflation hit a 4.5-year low, but output prices surged at the quickest rate in a year as companies transferred costs to consumers.
Boost In Business Confidence
Business confidence rebounded to a six-month peak, helped by hopes for increased demand and reduced trade tensions following a new trade deal with the U.S., lowering tariffs from a threatened 25% to 15%. The Bank of Japan maintained its 0.5% short-term policy rate, in line with expectations. Governor Kazuo Ueda raised the bank’s inflation forecast to 2.7%, attributing this to rising food prices and the positive economic effects of the trade deal with the U.S. The yen briefly strengthened, later settling around 150.67, slightly down from earlier peaks.
Based on the data from July, we see a Japanese economy that is sending mixed signals. The manufacturing sector is shrinking again, pointing to weakness, but the Bank of Japan is raising its inflation forecast, signaling a more hawkish stance. This conflict between a weak economy and a concerned central bank creates uncertainty, which is why the yen is struggling to find a clear direction around the 150.70 level against the dollar.
This environment suggests that betting on a straightforward move in the yen is risky in the coming weeks. A better approach for traders could be through options, as the conflicting data is likely to increase volatility. In fact, we’ve already seen one-month implied volatility on USD/JPY tick up to 9.5% this week, showing that the market is bracing for choppier price action rather than a smooth trend.
Implications For The Market
We saw a similar pattern play out during periods in 2023 and 2024, where speculation about a Bank of Japan policy shift clashed with weakening economic data. Those episodes resulted in sharp, unpredictable swings in the yen that often reversed quickly. The lesson from that time is to be cautious of sustained moves and instead be prepared for volatility.
For those trading the Nikkei 225, the situation is also complicated. A weaker yen is typically good for Japan’s large exporters, but the contracting factory output and soft domestic demand are clear negatives for corporate earnings. This suggests considering pair trades, such as favoring exporters over companies focused on the domestic market, rather than making a broad bet on the entire index.
The key thing to watch is the bond market and any future comments from Governor Ueda. The 10-year Japanese government bond yield briefly spiked to 0.78% yesterday, its highest since early 2024, which tells us that traders are taking the inflation threat seriously. Any further hints that the Bank of Japan will act on its 2.7% inflation forecast could trigger a significant strengthening of the yen, overriding the weak manufacturing news.
