Head of FX Strategy
Summary: The central bank pivot narrative was encouraged yesterday by more dovish than expected guidance from the ECB, which took the euro down a few notches. The Bank of Japan, not surprisingly, indicated full speed ahead with its existing QE and yield-curve-control policy, with a big new fiscal stimulus package from the government announced overnight possibly set to bring the kind of negative focus on the JPY that the Truss-Kwarteng budget brought on sterling, if with far less drama. After the ECB downshift, the market lean for a Fed downshift at next Wednesday’s FOMC meeting may make it difficult for the Fed to surprise on the dovish side.
FX Trading focus: Story overnight wasn’t BoJ, it was new Kishida stimulus.
The market is testing the notion that direction in US treasury yields is the chief driver for the US dollar direction as a strong further drop in the US yield curve yesterday has coincided with…a stronger US dollar. To be fair, US yields were dragged lower in large part by a drop in European yields, where surprisingly dovish ECB guidance saw the market marking down hike expectations over the next year by some 20 basis points even as they followed through with the expected 75 basis point hike that took the deposit rate to 1.50%. The news statement dropped specific language on “multiple” rate hikes, even if Lagarde’s press conference confused with offsetting language. A reminder of the very different balance sheet management situation relative to the Fed was the expressed intent to re-invest all maturing APP (asset-purchase-program) assets, with a further discussion of QT in December followed with implementation possibly late in 2023 (or possibly never, whichever comes later…). Three dissenters wanted a smaller hike. EURUSD dropped back below parity in response by late trading yesterday and has followed through a bit lower still in today’s session, but arguably needs to punch down through the 0.9900-0.9875 to suggest a more profound bearish reversal.
Somewhat more thematically interesting was the combination of Bank of Japan standing pat (not surprising) together with a big new fiscal stimulus package of over JPY 71 trillion, with 39 trillion of that in new spending – that is over $250 billion, or more than 6.5% of GDP. It will mostly aimed at incentivizing companies to hike wages, subsidies to reduce electricity bills and national security/defense initiatives. Remember the recent “mini-budget” from Truss-Kwarteng and its impact on sterling? Yes, the UK runs far larger external deficits than Japan, but the dynamics are similar, and Japan’s current account is shrinking rapidly again. The move to paper over energy prices with fiscal stimulus printed up by the Bank of Japan will merely keep demand elevated and continue to drive negative current account implications as long as energy prices remain high. It’s inflationary with no guarantee that the Bank of Japan will ever respond and yields essentially stuck at zero – all pressure goes to the currency unless the external dynamics change radically (collapsing energy prices, US Fed changing direction, long US yields plunging much further, etc…). If US data remains resilient, even as the Fed slows its pace of tightening, helping to driver long US treasury yields back higher again, we might expect to see a new lurch higher in USDJPY.
Chart: USDJPY
I wouldn’t have expected 145.00 support in USDJPY to survive so handily as US yields have punched significantly lower this week, but the big fiscal stimulus announced overnight in Japan and its inflationary implications, with no prospects for BoJ tightening in sight, puts a fresh source of pressure on the yen. If the FOMC fails to surprise strongly on the dovish side next week and US data remains generally resilient through next Friday’s US October jobs report, we could revisit 150.00 in a hurry.
Market leaning hard for a dovish FOMC shift. Yesterday, a Q3 GDP estimate looked strong at the headline, but was flattered by a far lower than expected GDP price index (a surprising 4.1% annualized versus 5.3% expected and 9.0% in Q2). The latest weekly jobless claims offered no suggestion that the strong labor market is faltering – will require several weeks of rising claims above 250k and confirmation from other indicators to suggest we are on the way to higher unemployment. The last data points we have ahead of next Wednesday include today’s PCE inflation data, where a core month-on-month print would provide the most USD-supportive impact. Given the ECB’s downshift yesterday and the smaller than expected hike from the Bank of Canada this week, together with considerable noise from an important source like WSJ Fed whisperer Nick Timiraos, the market is leaning quite hard for a dovish downshift at the FOMC next Wednesday. This sets the bar quite high for a dovish FOMC surprise, risking a “buy the fact” reaction for the US dollar if the Fed merely confirms that it doesn’t want to pre-commit to another large hike in December and thus keeps its guidance in-line with current expectations.
More central bank meetings coming up next week, including RBA Tuesday, and Norges Bank and Bank of England next Thursday.
Table: FX Board of G10 and CNH trend evolution and strength.
The negative USD trend is still in place, but is far closer to a reversal than it was yesterday in many USD pairs (EURUSD noted above, 0.6400 area in AUDUSD, 1.1500 area in GBPUSD), with USDJPY never having slipped into negative trending territory (see in individual pairs below). Elsewhere, continuing to watch sterling status as it may have achieved maximum rebound potential on Sunak becoming Prime Minister, as he and Chancellor Hunt are looking for ways to save £50 billion in fiscal outlays, deepening UK recession risks and curbing BoE rate hike potential. Already, the expected hike next week has dropped to 65 basis points from 100 bps less than two weeks ago.
Table: FX Board Trend Scoreboard for individual pairs.
Key through the FOMC meeting next Wednesday to monitor the trend status of the many USD pairs that have slipped into a downtrend for the greenback, with the notable exception thus far of USDJPY. EURNOK is trying to poke into a new down-trend but may find progress tough if risk sentiment continues to worsen. Certainly not expecting Norges Bank to add any upside potential to NOK next week.
Upcoming Economic Calendar Highlights
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