FX Update: USDJPY pokes at the brink again

FX Trading focus: risk appetite, the USD and US yields
This market feels rather pivotal with the current mix of cross-currents we have covered in recent days on the Saxo Market Call podcast. In today’s episode, I looked at the three prior major market tops and discussed the very different circumstances during those tops and what the market looks like this time around. The only situation that vaguely rhymes is the end Q3 market top, in which financial conditions looked fine across major metrics, but rising yields and the Fed balance sheet shrink. Again – “vaguely rhymes” is the key point, as this time, we have a US dollar that is weaker, a Fed that has no intention to shift direction, although US yields have been rising for months, and have accelerated at the long end of the yield curve since the beginning of the year.

I have recently outlined the scary implications in the event the US dollar continues to fall – especially if it does so aggressively – as US yields rise. So far it is too early to discuss either an aggressive rise in the yields (pace of rise is most important regardless of the level, but otherwise, the next major assessment takes place if the US 10-year yield is pushing on 1.50% vs. current 1.24%), and the pace of USD weakening has been nothing to write home about recently. But with yields potentially on the loose here, the attention I am directing to moves in yields far exceeds that of any other indicator. Note the USDJPY chart below, which is clearly also driven by the latest rise in US bond yields, and where Japanese yields have moved far less at the long end of the curve, widening yield spreads between the two.

As far as incoming drivers for the next move in US yields, the factors beyond incoming data will be the final size of the US stimulus package, where we already have a ball-park figure of at least $1.5 trillion, and any signals from the Fed. On the latter, the FOMC minutes tomorrow evening likely to come and go without much fuss, as the Fed leadership has tamped down on any discussion of tapering for now, an idea that was always laughable, given the scale of net treasury issuance in the coming twelve months that far exceeds the Fed’s QE and the ability for US- or foreign savers to absorb, unless they want to crash the economy with a brutal new acceleration in the savings rate. The conundrum of who will buy the US treasury issuance beyond Q2 (treasury has a ton of cash that can take it into Q3) is the single most pressing question to answer in coming months beyond how hot the US and other economies run as they emerge, increasingly vaccinated, from lockdowns. Eventually it will have to be the Fed. But at what level of inflation, employment, risk assets and bond yields does this take place? An excellent discussion of this very topic, by the way, in the MacroVoices podcast episode with MI2 Partners’ Julian Brigden.

Chart: USDJPY – a potential red flag for USD bears or in its own world?
USDJPY may not be as interesting as we are making it out to be – but the technical situation is rather compelling as the pair has traded up against the 200-day moving average again, clearly driven by rising US yields since the beginning of the year. We will continue to watch this pair for signs of a break higher – presumably because US yields are also heading higher – as well as whether the situation is a curiosity limited to USDJPY or drives an increase in volatility across FX and other USD pairs. For what it is worth, 3-month implied volatility for USDJPY is still very low at near 6.0%, even if this latest volatility has driven the slightest of rises.