
US/Japan: Improving trade relations between the US and China; Japan’s supplementary budget prospects. In less than three months since the commencement of the attacks on Iran, there has been a seismic shift in inflation dynamics and, consequently, expectations for Fed policy. With US headline inflation jumping by 140 bps in two months to 3.8% and core inflation likely heading towards 3.5% in the coming months, the market has given up all expectations of rate cuts under incoming FOMC Chair Kevin Warsh. The Fed would be reticent to hike rates soon, but short of an expeditious reversal in energy prices, defending a passive stance would become challenging. With economic activity showing sustained strength and recent labour market data remaining solid, the Fed’s next move is likely to be a hike, but not anytime soon.
During Trump’s summit with Xi Jinping last week, the preliminary creation of the "Boards of Trade and Investment" with China also marked a tactical cooling of Trump’s aggressive trade policies towards "transactional stability", which is less about global goodwill and more about a calculated retreat from a maximum-pressure campaign that ran into a wall of geopolitical reality.
For Japan, expectations of a supplementary budget are reviving momentum in “Takaichi trades”. In response to the potential economic impact of the Middle East conflict, Prime Minister Sanae Takaichi signalled on Monday that she has instructed the Finance Ministry to begin drafting an additional budget, reversing her earlier view that existing reserve funds would be sufficient. The cabinet is likely to finalise the package in mid-June, ahead of Diet deliberations, with the current session running until 17 Jul. Market discussions suggest a fiscal package in the range of JPY3tn-10tn, partially financed through additional government bond issuance. Spending is expected to prioritise gasoline and electricity subsidies, alongside broader inflation relief measures for households and SMEs.
Meanwhile, Japan’s preliminary 1Q26 GDP data indicate resilient growth of 0.5% q/q sa (consensus: 0.4%), driven by the AI supercycle and continued strength in semiconductor exports and capex. Japan’s April trade numbers are as strong as its East Asian neighbours, with exports growing 14.8% y/y (March: 11.5%) on the back of strong demand for chips. Import growth eased on lower oil purchases from the Middle East, leading to a larger-than-expected trade surplus. By and large, external demand has turned out exceptionally strong despite the Middle East conflict.

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