FX Update: What does a no landing scenario look like?

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

FX Trading focus: US yields breaking higher, boosting USD prospects, especially if “No landing” scenario develops. BoJ nomination fuss boosts yen, but hostile backdrop for JPY here.

The entire US yield curve continues to lift, with the latest uplift in the wake of a weak 30-year T-bond auction yesterday in the US, which saw some of the weakest bidding metrics in about a year. The 10-year yield today above 3.70% has broken to a new 5-week high, if still short of the major pivot high of 3.90% at the end of last year. We are also pushing on the highs for the cycle for the terminal Fed funds rate (currently just above 5.15% priced by the summer). And yet, while yields have marched higher in recent days, there is little drama or cyclical reassessment here: we are merely seeing the market mark its expectations incrementally higher for mid-year and only slightly delaying the anticipated eventual Fed rate cuts to come as soon as the end of this year, but more decisively next year. Evidence of that is something like the Dec '23 EuroDollar vs. Dec' 24 EuroDollar yield spread - still showing the latter at 145 bps lower yield than the former, a spread first reached almost a month ago. A proper change in the forward curve based on pricing a “no landing” scenario is something to watch out for in coming days and weeks. But what does that look like?

It probably looks something like the Fed moving to 5.25-5.50% or even 25 or 50 bps above that by later this year as the economy reheats and we see unprecedented tightness in the US labour market, with other data confirming fresh strength (US housing and construction is already picking up again) and even inflation and wages refusing to settle lower by late spring. With reheating data, the market will have to push those expected Fed cuts much farther over the horizon and re-asses whether the heavily inverted yield curve is justified – perhaps shocking the 10-year Treasury yield, for example, closer to par with 2-year rates, even as the latter rise as well – a bear steepener! That would likely in turn pressure global risk sentiment due to the vicious tightening of financial conditions as the disinflationary soft landing scenario is priced out. And it would keep the US dollar on the comeback trail for a major retracement of its sell-off from the top. Yields and incoming data are the key. And by incoming data, I am largely ignoring any surprise potential from the US January CPI next Tuesday, which could surprise on the downside due to a change in the calculation methodology. The best tell that market concern for a “no landing” scenario is rising would be a soft-ish CPI data point next Tuesday that is completely ignored by the treasury market.

Chart: USDJPY
USDJPY volatility has picked up today on an difficult-to-navigate set of circumstances. First, it emerged this morning in Europe that Japan’s PM Kishida will nominate Kazuo Ueda, a candidate not on any list of likely candidates before today, to replace Kuroda at the helm of the BoJ on his exit in early April. New outfits and researchers are busy plumbing all of Ueda’s prior statements for clues, but the academic and former BoJ board member looks a bit hard to pin down for any obvious direction from here other than that he is an experienced hand and certainly no radical, even if the lifting of the obviously dovish Amamiya (who declined the offer for a nomination) gave the JPY an initial boost today. Meanwhile, normally painfully negative headwinds for the JPY are building in the background, including the rise in yields discussed above (and a “no landing” scenario would require a massive adjustment in BoJ policy to support the JPY) and a jump in oil prices on Putin’s belligerent move today in announcing a cut in production by a half million barrels per day. Uncertainty rides high for now for JPY traders, but for USDJPY, I suspect the soft side is to the upside as long as US yields are setting the tone higher.