Trade war whiplash ahead of the FOMC

The market has been buffeted by trade war headlines in the space of well under 24 hours, first with an article yesterday suggesting that the US and China could be headed back to the negotiating table followed by news that Trump administration advisers overnight are arguing for an increase in tariffs on $200 billion of Chinese goods. 

The market is suffering from a rather bad case of headline fatigue on all things Trump policy-related, however, as the reaction has been rather muted – AUDUSD, for example, doing a round trip from 0.7405 to 0.7440 and back to the 0.7405 area this morning.

The follow-up reaction in the Japanese bond market and the yen to the Bank of Japan’s policy tweaks deserves considerable attention here, as JGB yields first plunged from the former yield ceiling around 10-12 basis points for the 10-year JGB back to about five bps yesterday on the disappointment that the BoJ wouldn’t abandon the ceiling. Now they have spiked all the way back to new highs overnight just above the old ceiling at a new 2-year high of 12.5 bps. 

This sets up a very interesting situation for the BoJ and the JPY if global yields pull higher again – note the US 10-year poised near 3.00% again and potentially threatening higher. 

If yields do continue higher in the US and elsewhere, the 10-year JGB yield would likely quickly pull to the new 20 basis point ceiling indicated by BoJ Governor Kuroda at yesterday’s press conference and, if the BoJ makes good on its YCC policy, the JGB “market” won’t be allowed to price yields higher from 0 to 10 years, meaning the yen will have to take the adjustment. A constant stream of unlimited JGB purchases and a sharply weaker JPY could sap confidence in BoJ policy and the nation’s currency in the worst instance. 

Of course, the entire scenario depends on US yields pulling notably higher, something they have failed to do in any sustained way since approaching the 3.00% level (for the 10-year benchmark) for the first time for this cycle all the way back in February. Still, stay tuned.

Today’s FOMC meeting has all of the makings of a non-event, but we’ll join everyone else in pouring over the statement for any tweaks that suggest a change of stance – unlikely in our view. Yesterday’s slightly weaker than expected PCE inflation data point was shrugged off, suggesting that the bar is a bit higher for pulling down Fed rate hike expectations.

Chart: EURUSD

Time for some resolution in the EURUSD chart as the pair has been triangulating for weeks – some have noted assumptions that August is a low volatility month because it is a summer month are misplaced – the key local levels look like 1.1500 and 1.1800, with the tighter formation breaks more like 1.1600 and 1.1750.