Head of FX Strategy
Summary: Japan’s inflation came in well above target again, but no hawkish shift seen in market expectations of Bank of Japan as wage negotiation results are awaited. This gives room for USDJPY to rise back towards 152 if Treasury sell-off returns, before a stronger recovery in yen ensues in 2024. Diverging EZ and UK PMIs saw EURGBP plunge to 0.87, but key supports ahead and US PMIs and German data due today will be on watch. EURSEK could also see more room on the upside after Riksbank paused.
Japan’s October inflation was reported this morning, and showed a re-acceleration after three consecutive months of softening. Headline CPI was at 3.3% YoY, higher than last month’s 3.0% and core also accelerated to 2.9% YoY from 2.8%, although it was below the expected 3.0%. Core-core measure however showed some signs of cooling but remained high at 4.0% YoY (vs. exp. 4.1% and prev. 4.2%). This continues to question whether inflation is really transitory as Bank of Japan has been saying, given headline inflation has been above the BOJ’s 2% target since April 2022.
While this could spook BOJ pivot bets, JPY hardly reacted to the release. One, there is still an element of one-off drivers in inflation. Much of the acceleration in October was driven by reduction in government subsidies that lifted utility bills, or higher hotel costs as inbound tourism accelerated. Higher import prices due to sustained yen weakness also continued to underpin. However, with the higher cost of living taking a toll on consumer spending, BOJ is unlikely to be convinced that inflation has become entrenched. As such, focus will remain on spring wage negotiations as that could be the only catalyst to prompt any BOJ tweaks next year, even if it remained minor.
That means yen will remain a play of Treasury yields for now, and US PMIs today but more importantly the PCE data next week will be key to watch. USDJPY has reversed back higher to 149.50 from lows of 147.15 this week. Pair could test 150 or higher as that level has been cleared for BOJ intervention risks earlier in October, while 152 could serve as an intervention risk threshold. Saxo’s trade signals also identify 151.86 as a key resistance. Germany’s suspension of debt limit serves as a reminder of fiscal dominance and could spark a sell-off in global bonds, which suggests near-term downside for yen. But valuation and positioning suggest a significant room for yen appreciation into 2024. If US PMIs indicate a moderation, USDJPY could reverse back towards 149.
Eurozone and UK PMIs conveyed a sense of stability and recovery, more pronounced in UK than Eurozone. UK services and composite PMI jumped up to expansion territory of above-50 and manufacturing also improved to 46.7 from 44.8. Eurozone PMIs however remained below 50, although both manufacturing and services showed an improvement. EURUSD came under some pressure on the release, but is sticking to the 1.09 handle for now. GBPUSD rose to highs of 1.2564 before settling in the 1.2540-area. That saw EURGBP pushing below 0.87 handle, although the break doesn’t look convincing for now and support level of 0.8647 will be on watch.
Fiscal concerns were also back in focus with Germany’s suspension of debt limits for a fourth consecutive year raising concerns of additional borrowing and increasing bond supply, which pushed yields higher. Germany Q3 GDP and IFO survey will be on watch today.
The Riksbank left the policy rate unchanged at 4%, but continued to signal peak rate of 4.10% in the beginning of 2024. The press statement says that the board is “is prepared to raise it further if prospects for inflation deteriorate”. However, the decision was unanimous, and inflation is seen to be declining inti 2024, indicating that the peak rate may have been reached. The board also indicated an openness to increase the size of the QT programme at its next meeting in January (announcement due Feb 1).
2024: The wasted year
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.
