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JPY the winner as yields dive on risk aversion.
John J. Hardy
Chief Macro Strategist
Résumé: The JPY is trumping the US dollar as a safe haven in a profound risk off event triggered by concerns that a Chinese AI model will disrupt the entire AI landscape.
While the stream of volatility-inducing Trump tariff headlines continues, another story from out of the blue has erupted across global markets in the crucial AI space and has blindsided risk sentiment. DeepSeek, a Chinese company has created an AI model on a shoestring budget that performs competitively with Open AI and Meta’s latest products and does so on inferior hardware. In addition, the product is open-source and transparent in how it works and reasons and is currently the most downloaded app in the US Apple Store. As of this writing, US Nasdaq futures were down over 650 points (about 3%) and the US dollar was mixed to flat after trying to pull back higher after Friday’s weak close. A story like this shoots right at the heart of the AI story that has driven the tech complex to such remarkable heights over the last two years. If this triggers a mini-crash in equities on the need to reassess the built-in assumptions of the scale of coming AI spending, it will be felt across markets, including FX. Presumably the JPY and US dollar would out-perform, with perhaps the JPY strongest if risk sentiment powers a surge in global bond-buying.
Chart: USDJPY
US dollar weakness Friday was chiefly on President Trump’s musings during a television appearance on tariffs against China, which he said he would prefer not to assess, while during the same interview he also reveled in the power he claimed he possesses in threatening the country with them because they are so afraid of them. The JPY didn’t manage much of a broad rally on the fact of the BoJ rate hike, and actually weakened later in the day as discussed below. The rally in Asia was a reflexive move due to the only combination that seems to feed JPY strength: risk-off and a dive in global yields. Let’s see where this AI disruption story takes us, but the next technical focus if the USDJPY pair can hold below 155.00 is perhaps the sub-153.00 200-day moving average or the 100-day moving average currently just below 152.00.
Regarding my three key questions from last Thursday, the first one: “Are US yields more important than a BoJ hike and guidance?” was already mostly answered on Friday as the market largely shrugged off the hike that was thoroughly priced in and the JPY generally traded weaker in the crosses to finish the day as global yields rebounded, especially in Europe on a stronger than expected flash PMI for January. It has also been answered in today’s market action as noted in the chart discussion above. My third question on Thursday “Is risk sentiment more nervous than it looks on the surface?” was apparently answered with yes, although whether strong signs of insurance-buying in the equities options market was on Trump tariff concerns more than this breaking DeepSeek story is an unknown.
My second question on whether the market is too complacent on the risk of Trump tariffs remains an open question, although the Trump-Colombia exchange over the weekend gives a sense of how rapidly things can escalate. It wasn’t just about the 25% tariffs Trump threatened for not allowing planes of deportees to land, it was the complex of other sanctions that might have risked shutting the country’s financial system down. Colombia backed down as will others who are to receive planeloads of deportees, but it will be worth monitoring the implications of the ill-will these power-moves from the US create as well as the degree to which Trump is willing to take this approach with larger trading partners like Mexico, Canada and Europe (less on deportees and more on other specific issues), but above all like China.
The week ahead – central banks a-go-go!
Wednesday
- Australia Dec. and Q4 CPI – Australia theoretically one of the more vulnerable currencies on CPI misses due to its lack of policy easing relative to global peers.
- Riksbank Majority of observers looking for a cut here followed by a pause – a fair assessment as the Riksbank has gone further and faster than its peers. SEK has refused to throw off any signals versus the euro. I would expect the outlook for the currency is positively correlated with the outlook for the euro and the EU economy – today’s action showing SEK can still trade sensitively to risk sentiment at times.
- Bank of Canada meeting – the bank indicated a slowing of its cutting regime after the last 50 basis point cut for now at the December meeting. The market almost fully prices another 25 basis points of easing. Tiff Macklem may try to be as circumspect as possible in its guidance, given the tariff risks, but the economy points to the need for more easing than priced (about 60 basis points total easing this year, most of it from here to the June meeting.)
- FOMC meeting The Fed is priced to stay put at the next two meetings to find its sea legs in the Trump administration and perhaps get a sense of where Trump policy is taking inflation and the labor market, so this meeting will not likely prove much of a catalyst. But there will extra focus heaped on how Fed Chair Powell continues to position the independence of the Fed after he has postured rather firmly on that point. We can expect a loud Trump exhortation to cut rates in the wake of this meeting.
Thursday
- ECB – the ECB will cut rates and is priced to do so again the following meeting, but with only 92 basis points of total cutting this year. I am in the dovish camp for more consistent cutting and at least reaching a total of 100 basis points earlier than the market expects if not actually ending up cutting 150 basis points this year. Whether it is too early for the ECB to signal this is difficult to discern.
Friday
- France and Germany flash January CPI – surely the ECB has had a peek at this data?
- US Dec. PCE inflation – data feels very old when we have moved into reacting to forward implications of Trump 2.0 policy mix.
Table: FX Board of G10 and CNH trend evolution and strength.
Note: the FX Board trend indicators are only on a relative scale and are volatility adjusted. Readings below an absolute value of 2 are fairly weak, while a reading above 3 is quite strong and above 6 very strong.
As the European session has worn on today, it doesn’t appear that weak risk sentiment is giving he US dollar any boost – most of it channeling into JPY – all of this too early to show in our trend readings. The most profound development over the last week has been the partial neutralization of the GBP bearish trend.
Table: FX Board Trend Scoreboard for individual pairs.
While the US dollar now looks in a downtrend against all other G10 currencies according to our board, the trend is still in the shadow of the enormous prior USD rally, so the jury is still very much out in most USD pairs. In EURUSD, let’s watch 1.0600 if 1.0500 doesn’t continue to provide resistance.