Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: USDJPY jumps to near five-year high on US yield surge
John J. Hardy
Chief Macro Strategist
Summary: USDJPY has surged to new multi-year highs as US long-dated treasury yields jumped higher on the first trading day of the year. Is that move narrative-based or more of a mechanical one based on shifting funds linked to the calendar roll? Time will tell, but as long as long-yield volatility persists, it will quickly dominate the focus. Elsewhere, the National Bank of Poland is already up with their first rate setting meeting of the year as they are expected to hike another 50 basis points.
FX Trading focus: US long yields surges and USDJPY responds: a red herring?
The first trading day of 2022 saw US long-term yields jumping higher, with the US 10-year Treasury benchmark risking some 11 basis points, one of the strongest moves in months. The most important exercise here is getting a sense of whether this move can extend, for which we must know what is driving it, something that will take a bit more time to determine. On the one hand, one might argue that higher long US yields make sense and are simply a delayed reaction to the drumbeat of promising news flow suggesting that the health impact of the omicron wave will prove limited and that the variant’s extreme contagiousness will mean it will burn itself out amidst rising herd immunity. Sure, the school/work/entertainment restrictions are a near term concern until we can get a sense of the pace of the declining trajectory on the other side of the impending case peak. So, the eventual lifting of all virus restrictions means growth unleashed and higher longer term yields.
Alternatively, as I argue in this morning’s Saxo Market Call podcast, the surge may simply be a mechanical development that is linked with the shift into the New Year as the big banks piled into treasuries to reduce penalties linked to their balance sheet size at year-end and then abandon those positions as the new calendar year gets under way. The Fed’s Reverse Repo facility, for example, spike higher into year-end to a record $1.9 trillion, and dropped about $325 billion in a single day yesterday, possibly helping boost yields.
Or there could be a bit of both, but the salient point is that if US long-dated yields continue to surge aggressively, they will quickly dominate the narrative, as discussed below in the UDSJPY chart description. It is worth noting that, while there are long periods of strong correlation between US longer treasury yields and USDJPY, it is not always present, as the latter part of 2017 and especially 2018 showed, and is always worth investigating when correlations break for signs that the narrative focus has shifted.
Chart: USDJPY weekly
Note the tendency for sharp mean reversion in USDJPY rallies and sell-offs over the last few years. As noted above, there is little to hold the pair back from higher levels if US long-term yields continue to surge, but if this is accompanied by a broadly stronger US dollar, the damage will quickly become self-correcting as the global reserve currency’s strength and higher interest rates quickly become toxic for risky assets and financial markets in general in a world swimming in excessive USD-denominated debt. Back in early 2017, note how the very sharp rally in USDJPY to the cycle high just above 118.50 from the late-2016 lows simply ended within a couple of weeks.
Elsewhere: EURPLN near two-month lows ahead of NBP rate hike today. The Polish National Bank meets today and will announce its policy rate, with consensus expecting a 50 basis point hike to take the rate to 2.25%. The central bank was slow off the mark to hike rates late last year, but eventually moved quickly and signaled a stronger tightening regime with a 75-bp hike in early November and a follow up 50-bp hike in December. EURPLN topped above 4.70 (new 12-year high) in late November and has since turned lower, trading below 4.60 and near two-month lows ahead of today’s decision, where hawkish guidance will be important for further PLN gains after inflation reached 7.8% in November and is expected at 8.2% in December. At the same time, the EU and Poland are embroiled in a conflict over rule-of-law issues that has seen EU recovery package funds withheld from the country until the issue is resolved, which could take at least another few months as the EU initiated legal action in late December, which Poland has two months to respond to, followed by as much as two months that the EU has to respond to Poland’s response.
Table: FX Board of G10 and CNH trend evolution and strength
JPY weakness is the most pronounced trending move on the FX Board, with sterling strength a bit of a head-scratcher in terms of drivers.
Table: FX Board Trend Scoreboard for individual pairs.
Watching how the first days and couple of weeks shape up for this year before drawing conclusions on some of the recent developments here.
Upcoming Economic Calendar Highlights (all times GMT)
- Poland Base Rate Announcement (no time given)
- 1500 – US Dec. ISM Manufacturing
- 1500 – US Nov. JOLTS Job Openings
- 1630 – US Fed’s Kashkari (non-Voter) to speak
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