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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: USDJPY saw most violent single day rally in over 20 years
John J. Hardy
Chief Macro Strategist
Summary: USDJPY ripped above the previous range highs with conviction yesterday, and the vehemence of the move has caught traders unaware. There could be far more upside to come if domestic Japanese investors are losing faith in their currency. Traders should respect the risk that volatility could be set to expand across the board.
Trading interest
- Long USDJPY with stops south of 110.50 – open target
- Abandoning EURGBP with stops above 0.8400
The USDJPY move yesterday was an earthquake that deserves our undivided attention and may prove the start gun for a significant expansion of market volatility after so many months of declining market trading ranges and implied volatility in options – to record lows nearly across the board, in the latter case. On Today’s Market Call we quantified the significance of yesterday’s move as the single largest one-day rally in “violence” terms if we measure the 1-day close-to-close move as a multiple of the recent ATR (50-day EMA of that indicator). At 3.4 ATR, this is the largest single largest “real” close-to-close rally adjusted for local volatility conditions in more than 20 years. We say “real” because there were four moves of similar or larger size in the 2010-14 period, but two of these were linked directly to major Bank of Japan meetings in which Kuroda made significant policy announcements, and the other two were Ministry of Finance intervention moves against prior bouts of JPY strength.
What is promoting the JPY decline? We saw Japan printing one of its worst GDP numbers (-6.3% annualized) in Q4, an ugly data point but one that many were willing to write off as linked to the sales tax hike in October as a similar pattern developed over the last major sales tax hike in 2014. But we all have our eyes on risks for this quarter’s numbers on the fallout from the Covid-19 virus and the risk that lingering concerns for travel and activity in general could persist for another quarter or more beyond this quarter and thus through Tokyo Olympics, etc.
As a side note, let us recall that the Bank of Japan has been the world’s most aggressive user of QE and has grown its balance sheet to over 100% of the Japanese economy, injecting plenty of liquidity into the system, but liquidity that has largely sloshed elsewhere on parlous growth prospects domestically. Looking at a gold-in-JPY chart, we have seen an incredibly aggressive ramping to all time highs that has only accelerated recently suggesting that Japanese investors may be losing faith in domestic assets and piling into US momentum equities (likely not hedged) and now precious metals and that stimulus measures from Japan will be too weak to matter.
What will this USDJPY move mean? It could mean a further ramping in the US dollar that forces the Fed to cut rates to the bone eventually – let’s recall the 2018 experience in both USDJPY and risk appetite and how that unwound in late 2018 and into early 2019. The question is whether the market finds solace in Fed easing or jolts into a new phase of concern that global growth is on the rocks and the central banks are doing too little too late.
Chart: USDJPY weekly
Yesterday’s USDJPY breakout turned into an incredible move higher, especially relative to recent calm. Technically, the break could not be more forceful, both in terms of the local range, but also on the basis of trend-lines. The next flat-line area of relevance is the 114.50+ area that capped the action since early 2017.
The G-10 rundown
USD – further USD strength until the Fed responds in sufficient size is the default stance here.
EUR – the euro getting less attention at the moment – most interesting test for the single currency is a chunky and persistent (i.e., more than a single session) risk-off move, which tests the narrative of the currency having become the funding currency of choice for all manner of corporate debt issuance and carry trade shenanigans.
JPY – see above on the JPY, the one currency dominating the market’s attention at the moment – and the EUR comments may also be relevant for the JPY.
GBP – sterling not enjoying this backdrop – GBPUSD has reversed badly and EURGBP is slipping back higher – sterling needs to pick up bids on hopes for a fiscal splash to remain a story.
CHF – EURCHF settling lower – whether historic correlations with risk appetite continue from here (see EUR comments above) our chief interest.
AUD – jobs report overnight seen as weak and Covid-19 news flow not helpful – AUDUSD punching to new cycle lows.
CAD – the CAD resilient on strong equities and ongoing crude oil bounce – but we’re no fans of CAD as Canadian credit cycle set to turn. Watching top of the zone in USDCAD as catalyst.
NZD – following AUD lower with market unwilling to differentiate much for the moment between AUD and NZD.
SEK – reversal zone for EURSEK is 10.60-65 if this recent bearish pattern is set for failure – risk appetite and growth outlook important factors (if both negative, raises risk of reversal higher for test of highs..
NOK – EURNOK pulls back from the brink of 10.00 as market doesn’t like the injection of volatility and weaker risk sentiment this morning – that is the line in the sand if the pair is to trade lower.
Upcoming Economic Calendar Highlights (all times GMT)
- 0930 – UK Jan. Retail Sales
- 1230 – Euro Zone Meeting Minutes
- 1300 – Poland Central Bank Minutes
- 1330 – Canada Jan. House Prices
- 1330 – US Feb. Philly Fed Survey
- 1330 – US Weekly Initial Jobless Claims
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