FX Update: Cross-market deleveraging revives old patterns

FX Trading Focus: Whiplash for JPY traders, US dollar also absorbs safe haven bid.

JPY gets an especially powerful boost on reversal of global bond yields. JPY traders were administered an ugly case of whiplash last week as the JPY had been weak across the board on more hawkish central banks taking global yields sharply higher, with EU yields having achieved lift-off all along the curve after the ECB meeting the week before and US treasury yields rising to new highs as  well, with the 10-year US Treasury benchmark above the 200 basis point level for the first time for the cycle. Adding to the pressure on the JPY was the announcement (before the US CPI release and Bullard comments on Thursday let us recall) from the BoJ that it would offer an unlimited bid for 10-year JGB’s in operations scheduled for today. The BoJ was doing this to defend the cap on 10-year JGBs at 25 basis points under its yield-curve-control policy after that yield had reached as high as 23 basis points. Alas, with a hefty dose of risk-off late Friday on shrill US warnings of an imminent Russian invasion of Ukraine as early as this week, safe haven seeking in sovereign bonds suddenly removed all of the pressure on the yield-sensitive JPY, taking USDJPY sharply lower even as the safe haven US dollar was bid elsewhere (more in chart below).

US dollar flashed interesting stripes before knee-jerk safe haven bid. I noted late last week that the US dollar actually traded quite soft relative to the fundamental backdrop as late as early Friday last week, as the drumbeat of rising Fed expectations and new highs in US long yields were not offering any notable support for the greenback. This suggests that only when such rises in yields are accompanied by risk-off deleveraging behaviour will this support the US dollar. Indeed, while yields suddenly retreated late Friday and into this week, the US dollar rose on the safe haven bid across asset classes.

ECB members try to talk down hiking intentions. At the week, Olli Rehn and Ignazio Visco of the ECB governing council tried to calm ECB rate hike expectations, with Rehn suggesting that a rate hike is not around the corner, but has gotten nearer. He also said that policy rates don’t impact energy prices and that wage rises have been subdued. The Banca d’Italia head Visco likewise noted the lack of pressure on wages. Lagarde is set to speak later today after she also tried to weigh in with dovish rhetoric last Thursday. As I noted in a presentation last week, the actual pressure on Italy from rising yields is extremely modest, as despite the massive debt load to GDP there, interest payments have almost only fallen since the early 1990’s and are at the lowest level they have been since then, with the ECB  now also owning more than half of Italy’s sovereign debt.

Chart: USDJPY
USDJPY corrected back toward 115.00, a psychological line in the sand, if not much else, and it is difficult to read the technical situation when the extreme geopolitical headline risk plagues the background. The two things to keep in view are the headlines and the coincident indicator – global safe haven bond yields – which have risen again today and taken the USDJPY back a bit higher. The JPY will likely go straight back to weakness if (a big if) the geopolitical situation fades persistently and yields resume their rise to new highs as it appears the Bank of Japan is not for caving on its policy just yet – though any hint of guidance for a policy review could see the JPY getting the treatment the Euro got after the ECB announced its intent to review policy. To the downside, the next areas worth watching are the 114.00-113.50 zone and then the 200-day moving average, rising from the 112.00 area at present.