FX Update: Story overnight wasn’t BoJ, it was new Kishida stimulus.

FX Trading focus: Story overnight wasn’t BoJ, it was new Kishida stimulus.

The market is testing the notion that direction in US treasury yields is the chief driver for the US dollar direction as a strong further drop in the US yield curve yesterday has coincided with…a stronger US dollar. To be fair, US yields were dragged lower in large part by a drop in European yields, where surprisingly dovish ECB guidance saw the market marking down hike expectations over the next year by some 20 basis points even as they followed through with the expected 75 basis point hike that took the deposit rate to 1.50%. The news statement dropped specific language on “multiple” rate hikes, even if Lagarde’s press conference confused with offsetting language. A reminder of the very different balance sheet management situation relative to the Fed was the expressed intent to re-invest all maturing APP (asset-purchase-program) assets, with a further discussion of QT in December followed with implementation possibly late in 2023 (or possibly never, whichever comes later…). Three dissenters wanted a smaller hike. EURUSD dropped back below parity in response by late trading yesterday and has followed through a bit lower still in today’s session, but arguably needs to punch down through the 0.9900-0.9875 to suggest a more profound bearish reversal.

Somewhat more thematically interesting was the combination of Bank of Japan standing pat (not surprising) together with a big new fiscal stimulus package of over JPY 71 trillion, with 39 trillion of that in new spending – that is over $250 billion, or more than 6.5% of GDP. It will mostly aimed at incentivizing companies to hike wages, subsidies to reduce electricity bills and national security/defense initiatives. Remember the recent “mini-budget” from Truss-Kwarteng and its impact on sterling? Yes, the UK runs far larger external deficits than Japan, but the dynamics are similar, and Japan’s current account is shrinking rapidly again. The move to paper over energy prices with fiscal stimulus printed up by the Bank of Japan will merely keep demand elevated and continue to drive negative current account implications as long as energy prices remain high. It’s inflationary with no guarantee that the Bank of Japan will ever respond and yields essentially stuck at zero – all pressure goes to the currency unless the external dynamics change radically (collapsing energy prices, US Fed changing direction, long US yields plunging much further, etc…). If US data remains resilient, even as the Fed slows its pace of tightening, helping to driver long US treasury yields back higher again, we might expect to see a new lurch higher in USDJPY.

Chart: USDJPY
I wouldn’t have expected 145.00 support in USDJPY to survive so handily as US yields have punched significantly lower this week, but the big fiscal stimulus announced overnight in Japan and its inflationary implications, with no prospects for BoJ tightening in sight, puts a fresh source of pressure on the yen. If the FOMC fails to surprise strongly on the dovish side next week and US data remains generally resilient through next Friday’s US October jobs report, we could revisit 150.00 in a hurry.