FX Update: ECB hawkishness gets traction. BoJ remains unmoved.

Today's Saxo Market Call podcast

FX Trading focus:

• ECB delivers hawkish stance, with strong upgrade to inflation/wage projections. Front end European yields jump higher
• Strong Euro response enhanced by weak US weekly jobless claims data point, unmoved BoJ overnight
• Yen in death spiral. Next steps are next Friday’s BoJ meeting and July 28 BoJ meeting
• Busy week ahead

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.