Looking at Japan and how the nation’s economy has evolved since the introduction of Abeomics, it becomes readily apparent that the famed “three arrows” of Japanese Prime Minister Abe’s plans have failed to hit their target. Despite wide ranging reforms and extreme monetary policy measures, the economy continues to struggle under the crushing weight of deflation and an ongoing global currency war. The phrase the most readily seems to define the economic reality is “spitting into the wind. ”The best intentions of officials have failed to produce a meaningful turnaround in the economy, forcing policymakers to rethink the direction. However, growing speculation that the Federal Reserve may act sooner to tighten policy further may alleviate some pressure on the Bank of Japan in their fight against deflation while helping USDJPY to rebound.

Tightening Around the Corner

Comments from US Federal Reserve officials alongside certain economic data points give credence to the idea that the Central Bank may be inclined to raise interest rates sooner than financial markets are currently anticipating. According to current futures contracts, the probability of a rate hike in June rose five-fold from levels reported earlier in the week following the release of the latest inflation data. Consumer prices, which continue to see headline gains, are gradually creeping higher, clearing the way for the Federal Reserve to act, especially if the figure nears the Central Bank’s 2.00% target sooner rather than later. While certain economic indicators such as the latest labor data may restrain the possibility of earlier action, especially after April’s disappointing job creation and weak wage gains, financial markets may be retreating from the more dovish ideology, contributing to the appreciating US dollar.

Although Fed Presidents including Dennis Lockhart and John Williams believe that the Central Bank is on a trajectory to raise rates between two and three times before the end of the year, markets are still not sold on the idea.Nevertheless, if the trend in inflation remains intact, the Federal Reserve may have no choice but to act in order to keep a lid on inflation should it begin to rise too quickly.While this has drawn concern about the potential to tip the US economy into a recession, the Federal Reserve seems less concerned about these developments. From their perspective, higher rates may curtail some excesses in the economy while forcing companies to invest more in R&D and production instead of financing share buybacks. The benefits of higher rates will not just be felt within US borders, but by other economies struggling to ward off deflation and stimulate growth, namely Japan.