Global Head of Macro Strategy
Summary: The ECB waxed very hawkish via the adjustments in its staff economic projections, which saw wage and inflation projections revised significantly higher. The impact on the euro was enhanced by the USD selling off on a weak jobless claims number and by the Bank of Japan proving unmovable once again overnight, which extended the yen’s recent death spiral. Looking ahead at next week, we have a heavy calendar of event risks.
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FX Trading focus:
ECB hawkishness boosts euro, with other factors in play
The ECB hiked 25 basis points as universally expected, but guided far more hawkish than expected in the press conference on the risks of second round effects and with the set of new staff economic projections. In the latter, the sharp adjustment higher from the March forecasts of core inflation (to for this year and next and even a nudge higher in the 2025 forecast suggests an ECB that is less confident that it will bring inflation down as quickly as previously hoped. Most importantly, and unlike the reaction to the “hawkish hold” from the Fed, the big move higher in front-end European rates held, driving a significant rally in the euro. That rally was given a boost by a weak US weekly initial jobless claims number that pushed long US treasury yields lower (that was my focus for USD direction yesterday, as the 10-year benchmark yield was perched near the cycle highs – only weak sentiment and/or strong surge in US long end yields seem to have a chance of supporting the greenback.) Looking at front-end yield spreads, however, the EURUSD rally is getting a bit rich here, with the extra boost likely coming from very strong risk sentiment. We will need to see the yield spread widening further to drive a EURUSD rally sustainably above 1.1000.
BoJ fails to move once again – July 28 meeting offering more potential?
The Bank of Japan entirely failed to deliver anything new or guide for a tweak or even conditionality at the next meeting on July 28. The recent hawkish shift elsewhere accentuated the negative reaction in the JPY, but as I note below in the discussion of GBPJPY, with long end yields in the main sovereign yield curves still anchored within recent ranges, this latest extension in JPY weakness is already looking excessive. We have a very interesting test for these JPY crosses over the week ahead if long yields don’t break higher and on the flurry of central banks set to meet next week (more below). Another test for the JPY will be Friday’s May Japan CPI data. Owning some upside optionality on the JPY through to the other side of the July 28 Bank of Japan meeting is an interesting proposition in the event that a) the Bank of Japan actually finally moves in the direction of tightening then, even with just a tweak or b) that we continue to see a failure of all of this CB hawkishness to feed into the long end of the yield curve and the global outlook continues to weaken.
Chart: GBPJPY
GBPJPY and other JPY crosses are soaring on the general shift toward more tightening and hawkish guidance from several central banks of late, while the Bank of Japan remains unmoved. As long as the long end of yields curves globally remain largely anchored, the move is arguably getting a bit stretched. With the Bank of England already priced to bring more additional tightening than any other G10 central bank, interesting to see next week if the Bank of England can deliver on guidance as the ECB did this week. Whenever this rally in JPY crosses ends, it will likely do so in spectacular fashion on a capitulation from the Bank of Japan or if yields come under pressure from the growth outlook. Downside optionality is perhaps worth owning through to the other side of the July 28 Bank of Japan meeting. Volatility looks rather inexpensive as few expect drama – but worth watching options pricing as that event risk nears.
Busy week ahead
Next week is a busy one on the economic calendar – a few notes:
Monday: US markets closed to mark Juneteenth.
Wednesday: UK May CPI is up ahead of the Thursday BoE meeting after the April numbers saw core inflation rocketing to a new cycle high and after the strong wage growth and labor market data last week that spiked UK yields higher. Also on Wednesday, we have Fed Chair Powell with his first of two days of semi-annual testimony before a House panel. We have just heard from him in the FOMC presser and the Fed seems very data dependent – doubtful that we get new signals here.
Thursday: Another central bank bonanza, with Norges Bank, the Swiss National Bank and Bank of England all meeting and all expected to hike a quarter point, with guidance important for all, but most anticipation certainly for the BoE, where so much is priced into the forward curve: almost another further 100 basis points beyond the hike next week for the Bank of England in particular. The Turkish central bank will also meet and is expected to normalize its policy rate to something close to actual prevailing rates in the country, so the official policy rate will be bumped from 8.50% to 20% or higher – with an interesting test for the TRY after a step-wise like revaluation post-election. Mexico will also announce its policy rate (no change expected after the long string of hikes and a mere 0.25% hike last time as MXN is increasingly priced for perfection). USDMXN has been a popular carry trade with its fat 11.25% policy rate, note the very steep backups that periodically hit the exchange rate.
Friday: Japan’s National CPI for May, which may challenge the BoJ’s forecast of easing inflationary pressures this year. Also up are the flash Eurozone PMIs for June, which have generally presented a picture of weak manufacturing sector and quite strong Services sector of late and with a slight dip expected for June.
Table: FX Board of G10 and CNH trend evolution and strength.
Note the acceleration in the downside momentum for the JPY in the last two and five days, while the CNH has stabilized (and even rallied against the USD yesterday). AUD leads the charge higher on the combination of hopes for more Chinese stimulus after the rate cuts there this week, on the hawkish shift from the RBA, and on key commodity prices on the rise, including copper. The USD has tilted lower and in determined fashion until proven otherwise.
Table: FX Board Trend Scoreboard for individual pairs.
Some wild readings in GBPCNH and AUDCNH – hard to believe in much extension there. Next week we’ll will be on watch for the latest trends’ ongoing status, including the lurch lower in the greenback.
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