FX Update: Geopolitics suddenly the most important overlay.

Today's Saxo Market Call podcast
Today's Market Quick Take from the Saxo Strategy Team

FX Trading focus: Geopolitical focus dominates, but subplots this week to include BoJ nominee appearance, today’s CPI shocker from Sweden and Wednesday’s possible no-hike from the RBNZ.

Not long after the US dollar was breaking free of resistance on Friday, US yields turned tail back lower ahead of the three-day weekend (US Presidents’ Day means markets closed in the US today), taking the US dollar down and arguably engineering a bearish USD reversal, if a so-far shallow one. Since then, we have new geopolitical developments that represent an entirely new level of risk to the global economy and markets after US Secretary of State Antony Blinken at the Munich Security Conference at the weekend warned China against providing any lethal military aid to Russia in its war on Ukraine. He claimed as well that the US has evidence that China is considering advancing such aid, and warned of “serious consequences” if it did so. China has yet to respond specifically to this allegation and markets are surprisingly complacent given what has just taken place.

Today, US President Biden touched down in Kyiv, Ukraine and strolled the streets there with Ukrainian president Zelenskyj in a dramatic show of support after Blinken’s rhetoric and after VP Harris late last week charged Russia with crimes against humanity. The implications are stark and if China makes an overt move toward supporting Russia’s military with lethal aid, the turn in sentiment would likely drown out all else as the market ponders the scale and speed of the de-globalization narrative and disruptions to global supply chains and trade networks on the inevitably harsh US sanctions. The immediate “winner” in the scenario might be the US dollar on the negative implications for sentiment, but possibly also the Japanese yen if investors rush to cash and to short-dated treasuries. The euro could also struggle (heavy exposure via trade, concerns on the Ukraine war effort on European security) against the Swiss franc, while risk-sensitive currencies might perform relative to risk itself, of course, but also relative to trade exposure to China (presuming AUD would be a significant under-performer on that account). Of course, there is a significant gray area between overt Chinese military support for Russia and the likely defiant rhetoric from China that it will make its own decisions on any matter. But needless to say, the coming days and weeks can transpire rather quietly on this front or can result in an event of historical proportions, and the probabilities of the one or the other scenario are impossible to calculate. Forewarned is forearmed as the saying goes.

Chart: USDJPY
USDJPY reversed back lower Friday after testing above 135.00 in line with the reversal of the rise in US treasury yields. The JPY should remain one of the most sensitive currencies to the direction in US yields, but also to the direction of BoJ policy, first on whether outgoing Governor Kuroda will want to make any waves in his final BoJ meeting as Governor on March 10, but also as the market awaits for the style and substance to come from the nominee to replace Kuroda after his exit in early April, Kazuo Ueda. The latter will speak before Japan’s Lower House on Friday. The recent 127.23 low was within a few pips of the 50% correction of the enormous surge off the early 2021 lows of 102.59 to the 151.95 top. Given the current US yield levels of 4.50% and higher for the US 2-year and nearly 4.00% recently for the 10-year, some measure of BoJ “normalization” is already in the price, but we have to remember that a significant Fed easing cycle for 2024 is already in the price as well, on the presumption that either a recession or a hefty disinflation is in the cards. The next six to eight weeks are critical for the JPY as the market gets a feeling for Ueda’s style and any new signals, while Kuroda has a chance to make a splash on March 10 and is set to leave on April 6, just after the end of the Japanese financial year on March 31. Tactically, the upside level of note is perhaps the 200-day moving average just shy of 137.00 currently, while the downside pivot zone is between 132.50 and 130.00 – awaiting signals from the drift in global yields and the policy signals from the BoJ.