Geopolitics paramount for German elections and BoJ, too?

Trump administration mayhem, Trump 2.0, Day 31
Trump and his administration continue to dominate the headlines over the latest news cycle since yesterday as we have everything from Trump’s harsh criticism of Zelenskyy and blaming the Ukrainian president for having started the war with Russia to Elon Musk floating the idea of handing out USD 5,000 checks to all Americans for all the money the DOGE will save on government spending. How committed the US is to supporting Ukraine in any deal with Russia is critical for the EU outlook and for the euro, as I have outlined in previous comments. The chunky surge in longer EU yields points to a major fiscal expansion in Europe – especially for Germany which runs almost no deficit, whereas the deficit-addled French budget will be in for a major shift in priorities, which will be difficult to pull off with the dysfunctional political backdrop there.

Best yet, the US State Department has recently snubbed China by removing the “People’s Republic of“ in referring to the name of the country. More inflammatorily, it also recently removed the phrase “we do not support Taiwan independence” from its fact sheet on relations with Taiwan, which is already eliciting a Chinese response. Yet Trump was out yesterday touting he will seek a bigger and better deal with China after he blamed Biden for not pushing China to adhere to the prior deal.

Yesterday, the FOMC minutes revealed a discussion of reducing or pausing quantitative tightening (QT), which put a top on the US dollar rally as yields fell slightly. That discussion is no major surprise as it has widely been seen as inevitable that the Fed will have to stop QT due to concerns on reserve balances if Congress can’t agree on a spending deal and the debt ceiling comes into play again.

Today’s focus: USDJPY breaks down ahead of Japanese CPI figures up tonight. Why?
USDJPY broke down quite heavily overnight, slicing through the 150.93 range support easily. There was no proximate trigger for the move save for a favourable if modest rally in US treasuries. Japan reports its January CPI data tonight, supposedly an important input in coming rate decisions, although the BoJ has touted ongoing wage negotiations as one of the most decisive factors. But I wonder if the force of the follow-up rally in the JPY here could be down to another source. Could it be that the market suspects that the Japanese government will view BoJ policy levels and especially yen levels as an important input in its relationship with the Trump administration? In other words, Japan has a long-standing persistent trade surplus with the US and has a very weak currency versus the US dollar and a very low policy rate, even if it has come well off zero. If a reasonably stronger yen is now a national priority rather than simply left up to market forces, the JPY could strong outperform relative to our normal coincident indicators like the level of long US treasury yields as Japan’s governments makes a concerted effort to move the needle. End of Japanese financial year volatility into March could also prove a factor. This is conjecture at this stage based on inference – the ongoing price action and whether 150.00 can be taken out before and after the CPI data as well as follow-up moves relative to coincident indicators will provide increasing evidence whether this hypothesis is on to something.

One interesting data point: On Tuesday, the US Treasury department data on foreign holdings of US treasury debt for the month of December showed Japan’s holdings falling USD 27 billion to reach their lowest level since 2019. Current holdings are at USD 1.06 trillion versus the 2021 high of 1.325 trillion. The January data point will be released March 19.

Chart: USDJPY
On my last update on Monday, I asked whether USDJPY might break all the way to 140.00 if the longer end if the US 10-year benchmark were to fall toward 4.25% and I continue to believe that’s a fair assessment of the potential outcome for USDJPY if US yields drop sharply, as the currency pair will remain sensitive to the trajectory of US yields as it so often has. But as I note above, as long as US yields are simply fairly quiet and not heading sharply higher, USDJPY may be able to continue selling off and thus diverging with the outlook for US treasury yields if the market feels that Japan may be eyeing its currency and its extremely low yields as a liability in the eyes of the Trump administration. The January National CPI figures for Japan are up tonight and are the next test for how sensitive the market is to month-to-month data versus a possible secular rerating of USDJPY – possible to the 125-130 zone eventually, but with the first focus on the huge 140.00 level if the price action slices decisively through 148.65.