USD/JPY Eyes Upside Risks Amidst Reduced Yen Shorts

The USD/JPY pair is heading into the week with yen shorts far less stretched than before the intervention episode of late July, reducing positioning risk. The key event this week is US inflation, which could materially shift expectations for Fed hikes over the next 12 months.

US CPI and PPI reports will take center stage on Wednesday and Thursday, respectively, helping shape expectations for core PCE later this month. Underlying consumer inflation has been running above the Fed's 2% target for around five years, while upstream producer price pressures have re-accelerated.

The focus remains on the inflation side of the dual mandate, putting emphasis on this week's inflation data, especially given the question marks over the signal from Friday's payrolls report. Another hot inflation print would make it harder for markets to keep whittling away at rate hike expectations, which have retraced from 62 basis points of hikes out to the June meeting next year to 42.5 basis points.

Outside of the inflation data, Friday's US retail sales report will provide a read on how consumers are holding up in this inflationary environment, and Treasury auctions could also influence yields at the back end of the curve.