Head of FX Strategy
Summary: The runaway downside in the Japanese yen was halted overnight by mixed comments from the Bank of Japan, which hinted at no change to its policy stance but noted currency volatility, with more pointed comments from the Ministry of finance. Elsewhere, financial conditions, at least in terms of market volatility, continue to ease and may be at a tipping point. Will this prompt a Fed response?
FX Trading focus: Some two-way action in JPY after BoJ comments. End of quarter ahead.
We finally saw a bit of two-way action in JPY crosses overnight after the brutal run lower in the Japanese yen over the last two weeks or so. Bank of Japan Governor Kuroda was out speaking with quite a mish-mash of comments. The preliminary March Tokyo CPI sees a similar pattern from the nation-wide February CPI numbers: a new high in the headline CPI, but with core mired near the lowest levels in a decade (-0.4% year-on-year versus -0.5% expected and -0.6% in Feb.). In Kuroda’s comments, there were no signs of him climbing down from the Bank of Japan’s policy stance and he even took the trouble to argue that a weaker Japanese yen is still supportive for the Japanese economy, arguing that inflation will be what prompts a change of policy and not the yen. And his view is that cost-push inflation like that seen currently won’t provide stable inflation of 2% over time and in fact harm the economy via a drop in disposable household incomes and corporate margins. Still, the Governor did say that the Bank of Japan is watching the currency closely, whatever that means, while the more credible Ministry of Finance (in terms of driving the actual currency interventions of the past, sometimes monumental ones) said overnight that disorderly FX moves are not desirable.
Albert Edwards, a strategist with Société Générale, put out a piece yesterday suggesting high risk of a further aggravated weakening of the yen if a carry trade develops as Japanese traders pile into foreign currencies and bonds while the Bank of Japan caps yields. This dynamic is certainly the risk as long as the Bank of Japan keeps its cap on 10-year JGB’s at 0.25% (these hit 0.24% overnight) and yields continue to rise elsewhere. Edwards also importantly points out that the widening gap between the real-effective value of the yen, currently at a modern low, with the very strong Chinese renminbi, suggesting a mounting pres. Last time, China had the luxury to “devalue” as it wanted to avoid tracking the US dollar’s further aggravated rise and because that very rise had crushed global commodity prices, particularly oil. That does not look at all like the current backdrop – but the situation looks very tense, nonetheless.
Chart: USDJPY
The USDJPY rally extension yesterday outran the latest move in US 10-year yields yesterday, which peaked very late in the day on Tuesday in the US before trading sideways, although we have seen a general extension higher in global risk sentiment coming into today, and easing financial conditions, both of which are wind at carry traders’ backs. The BoJ and Japanese Ministry of Finance comments overnight finally saw a dose of two-way volatility. And as we discussed on today’s Saxo Market Call podcast this morning, we are barreling into quarter-end (and Japanese financial year end) next Thursday after a particularly brutal quarter for bonds, which could bring some mechanical portfolio rebalancing that brings a bit of support for bonds and therefore possibly for the yen in the near term. But if the direction of bond yields remains higher whether now or beyond a quarter-end dip, the cycle top in JPY crosses may lie far ahead and possibly dramatically so if a significant cohort of traders pile into a new carry trade investment theme (as noted above), even if it is unsustainable in the long run. The next milestone is the almost 20-year high just shy of 126.00.
On the SMC podcast, we also highlighted the still-easy financial conditions in the US, as equities are gunning at the last major resistance ahead of the record highs after nearly the lowest weekly initial jobless claims print yesterday in US history suggesting a very tight US jobs market. One high yield credit spread indicator I track has tightened 60 basis points versus US treasury yields over the last ten days. Yesterday’s preliminary US PMI’s were solidly strong, suggesting no abrupt slowdown for now. Next week is key for additional economic data from the US, including the jobs and earnings data for March on Friday.
It feels like a long wait until the May 4 FOMC meeting if credit spreads continue to ease and equities gun higher. Will the Fed have to come out and one-up themselves once again – possibly with an indication of a super-size hike in May or even a hike between meetings? It’s not Jay Powell’s style, but this Fed continues to chase the market and inflation from behind. A Citi analyst has raised its own predictions suggesting the Fed will hike 50 basis points at each of the next four meetings. Hang on to your hats, folks.
The Russian ruble is down around 15% versus the euro since Russia invaded Ukraine, an incredible fact given the scale of sanctions against Russia, especially its central bank. But a recent Bloomberg article goes through the degree to which Russian can skirt sanctions, especially on the export side. The much more difficult task is the import side, as so many imports Russia needs are from sanctioning countries, but ironically this could help drive a widening current account surplus that helps support the ruble. Another article from Bloomberg discusses European concerns that China could aid Russia with high-tech components. The potential for knock-on and widening geopolitical conflicts stemming from the war in Ukraine and perceived “side-taking” remains a powerful risk. A phone summit with the EU commission’s Von der Leyen and Charles Michel and China’s Xi Jinping is set for next Friday.
Table: FX Board of G10 and CNH trend evolution and strength.
Not much new here, but the CHF is not following the JPY plot in any way, shape or form. Commodity strength clearly in evidence.
Table: FX Board Trend Scoreboard for individual pairs.
Note hefty ATR readings (top decile volatility for last 1000 trading days) all over the shop, with one major exception…..USDCNH. The tension builds….
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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.
