FX Update: JPY surge the big new surprise.

FX Trading focus: JPY trying to steal the spotlight from the US dollar with sudden surge

The most interesting development across market since the knee-jerk reaction to the more hawkish than expected turn at the Wednesday FOMC meeting has been in the US yield curve, with the front-end of the curve (and out to about five years) maintaining the jump in yields on the hawkish surprise, while the 10-year and especially longest end of the yield curve reversed and yields dropped sharply – the 30-year yield even posting a new cycle low. With the JPY sensitive to long US yields a well-established correlation (if an at times inconsistent one), the yen surged yesterday, with perhaps pressure on EM and sharply weaker commodities prices an additional booster to the long neglected currency, which I have felt for some time has been under-appreciated for its real yield credibility. That credibility was on display overnight as the country printed an unchanged headline CPI year-on-year in May. The Bank of Japan, meanwhile, generated headlines for planning a new facility to fund climate priorities starting later this year but was not a factor in the JPY move.

So we have an interesting setup heading into next week as many macro trades that have been popular since pandemic lows have hit a real speed-bump here on the Fed’s change of direction this week. Do we get a follow-on move for a counter-trend extension of this development for a few weeks? I lean toward the latter, given the initial strength of the move we have seen this week, partially contingent on today’s closing levels.

Chart: AUDJPY – that old “risk proxy”
A pretty powerful combination of factors lining up here against the Aussie and in favour of the JPY as the commodity complex has come in for a broad correction here, while long US yields just yanked down to new cycle yesterday despite the hawkish turn from the FOMC this week. A kicker was the reminder overnight in the form of the May CPI data out of Japan that Japanese real yields remain quite strong, while negative yields reign elsewhere. I have been looking for the risk of a JPY back-up for some time, but none unfolded until now, and the move could extend if long yields remain pinned lower and the sell-off in equities broadens (huge divergences yesterday in the US, with the median value stock down and quite badly, even as growth and momentum cheered the fall in longer yields). There’s certainly room for a considerable back-up in the JPY crosses without “breaking” anything, although any such move would likely have to see further downside pressure on long safe-haven yields and a significant further correction in commodities prices. AUDJPY is still within the multi-month range, but the focus looks lower if this move doesn’t immediately back up, perhaps eyeing the 200-day moving average, currently at 80.40, or even more to the downside if the market conviction in the trades that have proven so successful since the pandemic lows are in for a more significant consolidation.