Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: BoJ backed into a corner, tweak or no tweak.
John J. Hardy
Chief Macro Strategist
Summary: The market knows that the Bank of Japan is in the process of exiting the ten years of hyper-accommodation under Kuroda, and wants to front-run where Bank of Japan policy is expected to be a quarter or two from now, making it difficult for the Bank of Japan to navigate the transition as it despises extreme volatility. This has ironically meant enormous de facto BoJ QE in a rearguard action against . But even if the BoJ announces nothing new at its meeting overnight, significant volatility is very likely.
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Today's Market Quick Take from the Saxo Strategy Team
See Saxo’s Charu Chanana for an excellent run-down of the Bank of Japan meeting overnight as a starter. As Charu points out, we have a significant volatility event on our hands, with the chief uncertainty whether the BoJ capitulates now to a more significant shift in a policy, merely tweaks once again, or only guides for a further cautious adjustment in upcoming meetings. The only compelling reason for the Bank of Japan to go with the more dramatic option is to avoid continuing its rear-guard actions to enforce the top of the yield band at 0.50% for 10-year JGB’s. The BoJ’s holdings have ballooned a further few percent in the short space of a few months – ironically a massive QE liquidity boost for asset markets at a time when we are discussing impending tightening. So one angle on this is that, if the Bank of Japan sufficiently widens the band or steps away from capping longer yields entirely, this effective QE will come to a screeching halt. Not good for risky assets, but likely not bad for the US dollar as the greenback should always perform as a relative safe harbor in troubled markets. And here we’re not talking in USDJPY terms, but in other USD pairs (USDCAD, AUDUSD, GBPUSD, etc..)
So it may be important to consider that this BoJ meeting tonight is far more a JPY cross risk than a specifically USDPY risk. Other JPY crosses, like AUDJPY, may not have sufficiently adjusted to the implications of significant future tightening of yield spreads and 10-year Australian yields are also trading near recent lows, just as US longer yields are.
Chart: AUDJPY
As noted above, watching JPY crosses besides USDJPY as a measure of the JPY reaction to whatever the Bank of Japan delivers tonight. For AUDJPY, the important pivot area comes in around 87.50, with a break possibly leading to a test toward 81.00 (the 200-week moving average) or even 78.50 eventually on a huge reset of the JPY across the board. That fits with a USDJPY reset toward 115.00 (putting AUDUSD at around 0.6825) or with AUDUSD far lower if the USDJPY reset is far more modest, as massive volatility across markets might see the US dollar finding a solid bid in other USD pairs as a safe haven.
Elsewhere, we saw firmer UK earnings data for November (+6.4% YoY vs. +6.3% expected, ex Bonus, and vs. +6.1% in October) and the unemployment and claims data and revision were benign. The EURGBP rally has gone stale for some time now and may at risk of a reversal back lower. UK December CPI is up tomorrow. The market entirely failed to celebrate a neck-snapping reversal in Germany’s ZEW survey expectations for January to +16.9 from -23.6 in November, while the present situation index remained in the dumps at -586, failing to improve from the -61.4 n November as much as expected.
Table: FX Board of G10 and CNH trend evolution and strength.
The JPY dominating market attention into the Bank of Japan meeting overnight, with a secondary focus on the greenback if markets get particularly hairy. Note that the sterling weakness has almost completely faded as a theme.
Table: FX Board Trend Scoreboard for individual pairs.
All JPY crosses are in a down-trend – will the Bank of Japan put up a fight or let the JPY continue to rise by keeping the BoJ path to a semblance of normalization open? EURCHF has reversed back below parity, perhaps on the anticipation of a pick-up in volatility here – it has been a strange episode of volatility for that pair after the recent quick run above parity.
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