Chief Macro Strategist
Summary: The US dollar has been triangulating since the FOMC meeting last week and will likely have to choose a direction this week, one that is determined by whether we transition to a summer doldrums scenario or to fresh angst triggered by new upward pressure on global yields, led by US treasuries. Certainly, the JPY is already under fresh pressure as yields pushed higher in core Europe yesterday.
FX Trading focus: Fresh pressure on JPY as BoJ losing control. USD triangulating.
USDJPY is already back pressing on the cycle highs even as US treasury yields have merely bounced from pivotal levels (the US 10-year Treasury yield benchmark zone around 3.15-3.20% looks critical for the tactical outlook). The recent EURJPY dip was far deeper than the dip in USDJPY, and the rebound there has been sharper as EU core yields hardly consolidated and are pressed back higher yesterday after the ECB talked up the intentions with its new tool to compress peripheral yield spreads, an operation that could allow core yields to rise more than they otherwise would as this would mean that shifting balance sheet priorities would proportionally increase the supply of core bonds into the market – especially with the new expansive fiscal programs that lie ahead to address military and energy security concerns driven by the war in Ukraine. If US yields push higher again as well and take the 10-year Treasury yield beyond 3.50%, the pressure on the JPY will mount to eventually unbearable levels – but this last BoJ meeting shows that Kuroda and company will put up a considerable fight before folding. Last week, the Bank of Japan’s operations to defend yield-curve-control saw it accumulate $81 billion worth of JGB’s, a record for a single week. The BoJ has entirely lost control of its balance sheet and the JGB market is dysfunctional.
Chart: EURJPY
The EURJPY correction cut deep, but the rebound has come roaring back since the Bank of Japan meeting last Friday made it clear that the BoJ is refusing to budge, while core EU yields remain pinned near the highs of the cycle. The German 10-year yield is a remarkable 175 basis points this morning after trading below the BoJ’s yield cap of 25 basis points as recently as early March. The pressure on JPY crosses could become supercharged again if the key sovereign bond yields continue to rise to new highs for the cycle. And as we note above, core EU yields might find additional upward pressure from the ECB prioritizing a crushing of peripheral spreads.
Bank of England Chief Economist Pill was out this morning touting inflation risks and the importance of avoiding second round effects, while also noting that monetary policy is a “blunt tool” for moving against inflation, while admitting that the BoE is willing allow growth to weaken if that is what it takes to move inflation back to the target. The market hasn’t been particularly volatile during a series of comments this morning as short UK yields trade at cycle highs, but it was interesting to see Pill bring up the exchange rate in his comments, as something that needs to be taken into account. With global commodities priced in US dollars and the GBPUSD rate having fallen some 10% from its January highs, it is an important point.
A speech from RBA governor Philip Lowe overnight took Australia’s short yields a notch lower as that the July hike from the RBA would be 50 basis points at most, moving the market to cut anticipation of a larger rate hike – and in a Q&A, Lowe said that the board would only consider a rate hike o 25- to 50 basis points. The RBA sees Australian inflation rising toward 7% in Q4 of this year. Given that the RBA is the only central bank that still meets on a monthly basis, this doesn’t have to look so dovish, as the bank can simply hike 50 basis points at every meeting if conditions dictate. More than from the RBA, the risk for further AUD weakening stems from any return of weak global market sentiment, and more specifically, to Chinese demand concerns as key commodity prices are struggling. Copper, for example, a bellwether metal is trading near the range lows stretching back and Australian mining giant BHP Billiton’s share price is hovering near its 200-day moving average.
Noted hawk James Bullard, president of the St. Louis Fed, was out with fresh hawkish comments yesterday, but the market has not reacted to these. He emphasized that it is important for the market to move as quickly as the market is currently pricing and to prevent inflation expectations from coming “unmoored”. He highlighted the interesting divergence in actual inflation readings and falling inflation predicted by TIPS (inflation protected US treasuries), which “will have to be resolve, possibly resulting in higher inflation expectations”. US Fed Chair Powell is set for two days of testimony before Senate and House panels tomorrow and Thursday, respectively. For USD direction, I have eyes firmly pinned on whether the US 10-year treasury yield remains tamed. On Friday, we get the final June University of Michigan sentiment survey, which includes a longer-term inflation expectations survey that garnered huge attention when it suddenly jumped to 3.3% from 3.0% in the initial June release.
Table: FX Board of G10 and CNH trend evolution and strength.
As noted, the US dollar has been triangulating since last week’s FOMC and will need to choose a tactical direction soon. NOK is in for a test on Thursday on the Norges Bank and whether it is set to change its cautious pace of rate tightening. Elsewhere, CHF impulsive strength on the back of last week’s SNB has yet to blossom.
Table: FX Board Trend Scoreboard for individual pairs.
The individual pairs are short on tactical developments but watching whether the USD comes under pressure or renews its bull trend in coming sessions. Note AUDCAD at a tipping point supposedly, but actually trading in a volatile range – likely to copy the direction of AUDUSD from here. And speaking of AUD charts – watching EURAUD for upside break potential if 1.5200 breaks.
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