Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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FX Update: Market challenges BoJ. ECB set to hike 100 bps?
John J. Hardy
Global Head of Macro Strategy
Summary: The JPY is tumbling again even as yields trade relatively sideways and as the grinding disparity widens between the Bank of Japan’s yield caps and rising front-end policy rates and rate expectations elsewhere, most notably in Europe, where the ECB nonetheless needs to hike 100 basis points if it really wants to impress markets this Thursday. In the background, the US dollar is a bit sideways, while sterling has launched a relief rally on the arrival of Liz Truss as new UK Prime Minister.
FX Trading focus: Market challenges BoJ again. ECB has to hike 100 to impress.
A new runaway move lower in the JPY is the focus today even as yields at the longer end of the yield curve remain relatively anchored after a modest correction late last week. The focus may simply be on the widening divergence between policy rates ratcheting higher everywhere else while the Bank of Japan maintains that it will not budge any time soon. Some thoughts on EURJPY below, while USDJPY has cleared 141.00 and has not traded this high since a brief episode of a few months in 1998 during the Asian financial crisis. The Bank of Japan YCC policy is under duress and the pressure will ratchet that much higher if the US 10-year yield. Already with this latest move we should expect some stiffening verbal intervention that inevitably won’t last long.
EURUSD teased back towards parity for whatever reason this morning, perhaps in hopes that the European energy cap plan will prove a boost, perhaps on hopes that the ECB is set to surprise to the upside at Thursday’s ECB meeting. It’s a long shot according to the odds, which strongly favour a 75 basis point move over a 50 basis point move, but if the ECB wants to play some real catchup and help stabilize the euro currency, it should hike rates 100 basis points and indicate a willingness to do so again. It is not helpful for Europe that the Kremlin has now explicitly made it clear that the failure to restart deliveries of gas through the Nord Stream I pipeline are a weaponization of gas flows aimed at EU sanctions. Everyone is becoming a natural gas expert now, with the gist that the EU can survive the winter with no Russian gas as long as demand drops around 20% and there are no further disruptions of other non-Russian supplies. The situation would have been far better had not French nuclear woes and a massive drought impacted hydroelectric production not created the perfect storm this winter for power prices.
Chart: EURJPY
EURJPY is an interesting to watch in addition to USDJPY as the pair has traded back to new highs despite Europe’s dire energy situation (to a significant degree, Japan is also beset with high energy costs, given its reliance on important LNG and oil). But the ECB policy rate anticipated through the December ECB meeting is some 70 basis points higher than it was in mid-August, while the Bank of Japan carries on its yield-curve control policy, helping to pump this cross back higher. Next key test is over the ECB meeting on Thursday and then whether US data this week and through Monday’s August CPI data point excites a further rise in US treasury yields.
Freshly minted UK Prime Minister Truss used her first day in office to launch a £130 billion package to cap energy bills at their current level in order to avoid the cost-of-living crisis for many had bills risen as scheduled to nearly double the current levels next month. The cost estimate is spread over 18 months and represents some 5% of UK GDP now, (likely considerably less next year, given the runaway nominal growth in the UK economy at present). Sterling has seen a solid relief rally on hopes for Trussonomics, which will include tax cuts and a possible threat to Bank of England independence. Longer term efforts to increase investment in new energy sources could pay long term dividends, but the UK and its currency can ill-afford aggravating already yawning deficits in the near term, and further Bank of England rate hikes will aggravate risks to growth/real estate while piling onto the stark mathematics of future deficits and sovereign cost-of-debt-service calculations. Still, it is a riveting effort to watch as Truss and her strong Conservative majority can show more dynamism and force in policy making than we are going to get in the near to medium term from the US or Europe.
Australia’s RBA hiked 50 basis points as almost universally expected and claimed in its statement that it is on “no preset course”. The front-end of the Australian yield curve hardly budged on the news after some intraday volatility as the market expects higher odds that the RBA downshifts at tone of the coming two meetings to a 25-bp hike. RBA Governor Lowe is set to speak on Thursday, an event that could provide a stronger bias than the neutrality we saw last night.
Note fairly strong new highs in USDCNH today above the cycle high and within reach of the psychological 7.00 level now (7.20 area nearly touched in 2019 and 2020 the cycle focus and the CNY hasn’t shown much independence of movement in the crosses.)
Table: FX Board of G10 and CNH trend evolution and strength.
Sterling trying to make a comeback in momentum terms, but is only about halfway to notable resistance in the key EURGBP and GBPUSD pairs. Elsewhere, not the recent CNH downside momentum and Aussie following suit to a degree, while the JPY takes the crown for most negatively trending currency in our universe.
Table: FX Board Trend Scoreboard for individual pairs.
The AUDNZD upside attempt is faltering – is it set to flip negative? Elsewhere, note GBPJPY and SEKJPY trying to set the direction back higher, a sign of the broadening downside pressure on the JPY.
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