Market Strategist
Summary: The upside surprise in US consumer confidence for March despite the banking sector concerns is reflective of a still-tight labor market being more meaningful to an everyday consumer. If banking sector concerns don’t flare up and US economy and inflation remain firm, the Japanese yen could give up more of its gains in the near-term. But the pinch of the incoming recession will likely bite US consumer into H2 as credit supply tightens. Policy tweak from incoming BOJ Governor Ueda is also still not ruled out, and scope for further gains in yen remains.
A sense of calm is prevailing in the markets currently, especially compared to the turbulence of the last few weeks since the banking concerns started to hit. The driver of this calm, primarily, is that no other bank has reportedly failed in the last few days. Whether that is enough for a rebound in risk sentiment, we will only know that in a few weeks/months considering if this rebound sticks or not.
The US consumer has shrugged off the banking worries for now. The US Conference Board survey of consumer confidence signalled further strength in March, rising to 104.2 from an upwardly revised 103.4 (consensus 101.0) for February. The present situation index dropped from 153 to 151.1 while expectations rose from 70.4 to 73.0. The strength of the index may be a slight surprise as the cutoff date for survey was March 20, a few days after the US bank failures hit. Improved sentiment despite bank failures and equity drawdowns is likely a result of lower fuel costs, the ongoing tight labour market and rising wages. It is plausible that day-to-day consumers will only feel the pinch of tighter credit conditions much later in the cycle.
Meanwhile, high inflation and interest rates, as well as the risk of credit availability becoming restricted mean consumers could turn more cautious in the second half of the year. A possible hit to the labor market also cannot be ruled out. If data starts to show labor market may deteriorate, and with market already pricing in Fed rate cuts from Q3, it will be tough for the “bad news is good news” syndrome to prevail.
With this (possibly false) sense of calm, US 2-year Treasury yields are back above 4%, retracing nearly 38.2% of the slide from the peak of 5.1% seen on March 8 to the low of 3.6% on March 24, along with hefty moves of over 60bps on several days in between. Despite this sharp fall in yields due to the concerns around the banking crisis, the Japanese yen has only gained 3.4% against the USD since March 9, which isn’t a huge recovery considering over 12% decline in the Japanese yen against the USD in 2022 as yields rose. However, the run back higher in yields now with the sentiment recovering has reversed the recent safe-haven gains seen in the Japanese yen. USDJPY rose to 131.80 from lows of 129.64 seen at the end of last week.
Banking sector risks may be abating now, but what would be left from the events of last 2-3 weeks will be flight of deposits from smaller banks to larger banks and money markets or other safer/higher interest rate tools. That will leave the banks with no choice but to tighten lending standards, crippling the economic momentum. Markets are yet to price in that risk of an incoming recession, which has been significantly increased by the recent events in the banking sector.
Governor Kuroda is leaving the office in a few more days, and incoming Governor Kazuo Ueda has signalled policy continuity. But he has ruled out further tweaks to Japan’s yield curve control policy, and wage and inflation pressures continue to build up in Japan. The spring wage negotiations this year for Japan’s major companies resulted in average pay rise of 3.8% for the financial year that begins in April, exceeding market expectations. No doubt this represents a small proportion of Japanese corporates, but it weakens the argument that Japan’s inflation is not driven by underlying strong consumer demand and will slow as the cost of imported commodities falls. Headline inflation may be easing due to the decline in commodity prices, base effects and fiscal measures, but core readings have still remained high and the breadth of price pressures also continues to increase.
That means the pressure on Bank of Japan to tweak policy will stay. Governor Kuroda, at his appearance in the parliament today, also hinted at strengthening wage pressures in Japan. The tone was a marked shift from his earlier uber-dovish stances, and keeps the door open for any policy tweaks from incoming Governor Ueda.
BOJ did not yield under immense market pressure last year as that would have meant losing credibility. But with the market pressure easing and inflation pressure staying, that will be the perfect excuse for BOJ to tweak its policy stance. However for that to happen, financial concerns have to remain contained, and global recession, if one was to happen, has to be shallow so economic prospects for Japan do not weaken materially.
The sharp move lower today in the Japanese yen may have come from some year-end flows as Japanese companies close their books annually on March 31. If banking sector concerns continue to ease, or the US economy stays firm, or if we get further inflation shocks from PCE this week or the next CPI release, market pricing has room to turn slightly hawkish.
The Fed is guiding for a pause after reaching peak rates of ~5.1% but the market is still pricing in three rate cuts for this year. This gap could mean some short-term pressure on the Japanese yen. USDJPY could target 133, close to the 50DMA and 23.6% retracement level but 135 will be the bigger test. In the medium-to-long term however, as recession risks start to bite, there is further room for the yen to recover especially on the crosses particularly EURJPY and GBPJPY.
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