Head of FX Strategy
Summary: The Friday meltdown in USDJPY and JPY crosses was all about position squaring as we had just come from a place of anticipating a more hawkish shift from central banks, particularly the US Fed. The sense of whiplash was most acute in USDJPY, which had just been up testing multi-year highs before the deleveraging across markets on the new omicron covid variant clouding the outlook.
FX Trading focus: Narrative whiplash for JPY traders on omicron variant concerns
The news of the new omicron variant of covid could not have come at a more difficult time for the market to absorb for at least two reasons. First, of course, was the poor liquidity when US markets were closed Thursday and only open part of Friday due to the Thanksgiving holiday. Second was that we had just earlier the same week seen Fed Chair Powell and Brainard elevating the relative focus and position of grappling with inflation in their acceptance speeches, which had sent Fed rate hike expectations to new highs for the cycle early last week before the news hit. That ratcheting up of Fed rate anticipation had helped take USDJPY to new highs since early 2017 above 115.00 and EURUSD to new lows below 1.1200.
But the positioning build-up in USDJPY has been far more extreme and the reaction in JPY crosses on Friday was fully in fitting with the JPY’s old status as a safe haven. Note that AUDJPY had its worst single-day drop since the heart of the pandemic outbreak panic in March of last year, while EURJPY has poked below the important 128.00 area that would suggest a break-down if the move holds. EURUSD rose sharply, as the sudden repricing of the Fed saw the EU-US yield spread tightening sharply, but the move would have to extend as far as 1.1500 to start having more profound technical implications.
Has the market taken the news too far? That is not for me to judge, as it will take some time to assess the status of the reach of the current outbreak transmissibility, virulence and vaccine-evading characteristics of this new variant, all while real damage is being done as some countries are limiting travel, some merely from the areas where the new variant was discovered in southern Africa, while Japan has announced a full ban on inbound travel starting tomorrow. US President Biden will speak on the new variant later today. What does the best outcome look like? The omicron variant proves very transmissible, but is considerably milder and/or not particularly good at getting around the existing vaccines. Worst case involves some combination of significant vaccine evading characteristics and virulence that is anywhere similar to prior variants.
I suspect that without immediate good news (real news surely requires at least a week from here?), the uncertainty could see risk-correlated trades dragged lower before things can improve, but a significant further deterioration in risk assets would likely require actual bad news emerging rather than merely an extension of the uncertainty. Regarding a timeline for learning more about the risks from the omicron variant, it’s best perhaps to admit that I have no clue, but a Reuters article suggests the major vaccine makers may be able to determine efficacy of existing vaccines in about two weeks.
Chart: USDJPY
While other JPY crosses were bigger movers on Friday, the technical development in USDJPY was the most remarkable, as it came off new cycle- and multi-year highs. The damage is significant locally, but would turn more severe if the 112.73 pivot low from October is broken and then goes on to challenge the more structurally significant 111.50-111.00 area.
Looking at the week ahead, we would normally be touting the importance of the next set of US survey numbers (November Consumer Confidence and November ISM Manufacturing on Wednesday and ISM Services on Friday) and November jobs and earnings numbers on Friday, but instead, we’ll have to juggle the ongoing news flow and headlines from the new virus variant and may have to file these data away for a later “pent-up” reaction if the omicron variant impact dissipates. Besides the US dollar and the JPY, I will watch all points on the US yield curve and risk sentiment measures closely for how the market is reading the situation. Powell is out today with opening remarks at some event - more interesting is testimony tomorrow, together with Treasury Secretary Yellen, on the policy response to the pandemic, which could see interesting exchanges on inflation, etc.
Table: FX Board of G10 and CNH trend evolution and strength
The JPY is in a very different place from where it was a week ago or even two trading sessions ago and looks to remain the high-beta currency to whether the virus news drags market sentiment. The SEK reading looks extreme, but difficult to fade in terms of picking levels – downside put spreads in EURSEK the cautious way to proceed for those interested in fading this move now rather than waiting for a reversal pattern to develop.
Table: FX Board Trend Scoreboard for individual pairs.
Talking trends is treacherous business when the market goes into headline reactivity mode, but note that USDJPY and CNHJPY turning negative (if they close lower today) would make it a clean sweep for the JPY across the board.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
