The Yen is Beaten Down After BoJ Stands Pat
Today’s Financial Markets Highlights
- • The US dollar is consolidating after yesterday’s broad retreat.
- • The main exception is the sharp decline in the Japanese yen following the Bank of Japan’s refusal to modify its aggressively accommodative policy. An unusual reference to monitoring the foreign exchange market (and financial markets more broadly) was included but lacked teeth, and in any event sparked one of the largest selloffs of the yen seen in several weeks. The widening policy divergence would seem to reduce whatever chances there may have been for intervention.
- • The market recognizes that other central banks have pivoted in a more hawkish direction. The year-end policy rate in the UK is now seen above 3.0%, which is up more than 25 bp this week. The year-end rate in Australia is seen around 3.85%, up 70 bp this week.
- • The ECB appears to be moving into the direction of targeting intra-EMU bond spreads. This is fueling a dramatic bond market rally in Europe and peripheral-core spreads are narrowing sharply.
- • The year-end Fed funds target rate is now seen a little above 3.55%. It was slightly below 2.75% at the end of May.
- • Fed Chair Powell repeatedly said that there were no signs of a broad economic slowdown in the US. This seems unduly optimistic.
The large bourses in the Asia Pacific fell today after sharp losses in the US yesterday. China and Hong Kong were exception, posting more than 1% gains. The mainland markets closed higher on the week. Europe’s Stoxx 600 made a new low for the year before recovering. It is up a little more than 1% around midday. US futures are around 0.75% higher. The US 10-year yield is firm near 3.20%, while the rally in European bonds and narrowing peripheral-core spreads continues. Italian, Spanish, and Portuguese benchmark yields are 18-20 bp lower, while German, French, and Dutch yields are 7-9 bp lower. The greenback is trading with a firmer bias, with the yen being tagged for around 2% after the BOJ showed no intention of addressing the yawning divergence of monetary policy. The Norwegian krone and Swiss franc are the most resilient. Among emerging market currencies, the freely accessible ones are the most resilient today, including the South African rand, the Polish zloty, and the Mexican peso. Gold has risen by almost $50 an ounce over the past two sessions but has come back offered today and is hovering around $1850. July WTI continues to recover from its 4.4% slide in the first few sessions this week. It gained almost 2% yesterday and is up another 1% today and is near $119. US natgas is edging higher and is near $7.50 having finished last week near $8.85. Europe’s benchmark has surged 55% this week as US and Russian supplies have been disrupted. Iron ore extended its sell-off for the seventh consecutive session. It is off about 18% in this run. Copper is faring a bit better, but it has fallen in five of the past six sessions coming into today and is off another 0.5% today. It has fallen a little more than 8% during this downdraft. July wheat rose 2.7% yesterday and is little changed so far today.
The Bank of Japan stood pat, recommitted to its yield-curve control and daily bond purchases, driving the yen sharply lower. Governor Kuroda appeared to have made one seemingly minor concession. The BOJ’s statement included a reference to the markets, saying that the impact on foreign exchange market and financial markets would be watched. This did not deter market participants from selling off the yen as the divergence of monetary policy is maintained. The dollar recovered from yesterday’s low around JPY131.50 to almost JPY134.65. In this context, intervention, which has not seemed particularly likely seems even more remote now. A statement from the G7 (June 26-28) may not deviate from the boilerplate references that foreign exchange rates are best set by the markets, but excessive volatility is undesirable.
The combination of a larger than expected RBA rate hike last week, a bigger than expected rise in the minimum wage, and hawkish comments from central bank Governor Lowe has sparked a dramatic adjustment in Australian rate expectations. The implied year-end rate of about 3.85%, is up 70 bp this week after the 80 bp rise last week. The 10-year yield has risen for the third consecutive week for a cumulative increase of almost 90 bp to above 4.10%.
The dollar peaked on Wednesday at a 22-year high around JPY135.60 before reversing lower. It posted a key reversal by making new highs for the move and then settling below the previous session’s low. There was follow-through dollar selling yesterday to JPY131.50. In the aftermath of the BOJ meeting, the dollar has jumped back and approached yesterday’s high that was just shy of JPY134.70. There is an option for almost $700 mln at JPY135 that expires today. The greenback was around JPY134.40 at the end of last week. The two-day rally that lifted the Australian dollar about 2.5% stalled near $0.7070 yesterday. It is straddling the $0.7000 in late morning dealings in Europe. At $0.6960, it would have given up half of the gains since the June 14 low (~$0.6850). The option for almost A$500 mln at $0.7000 that expires today appears to have been neutralized. The Aussie settled last week near $0.7060. The greenback traded quietly against the Chinese yuan and was confined to the smallest range of the week, trading between roughly CNY6.6915 and CNY6.7060. The PBOC set the dollar’s reference rate at CNY6.6923, a little lower than the median in the Bloomberg survey of CNY6.6944. The fixings have alternated this week between a stronger and weaker than projected yuan. The dollar is a little lower on the week, having closed near CNY6.7090 last week.
The Bank of England hiked the base rate by 25 bp. It warned that rather than expand by 0.1% this quarter, the economy was likely to contract by 0.3%, and inflation would peak closer to 11% than 10% as it suggested previously. Three members dissented in favor of a 50 bp increase. The statement said the central bank is prepared to act more forceful if necessary. The year-end rate implied in the swaps market jumped 16 bp to 3.0% yesterday and is edging a little higher today. It is pricing in about 185 bp of hikes in the four remaining meetings of the year. That is more than a 50 bp hikes are fully discounted for the next three meetings, plus a little more.
The ECB built market expectations earlier this week when it needlessly announced an emergency meeting to discuss the market. Nothing new came of it but instructions for others to have another meeting and devise a tool that can be used to fight the divergence of interest rates, which ECB President Lagarde says can interfere with its price stability mandate. Lagarde appears to have briefed the eurozone finance ministers that the ECB intends to put limits on bond spreads. Details ae still lacking, but ostensibly the purpose is to curb sharp moves in short-time periods, and address what Lagarde called “irrational” moves. The tool sounds a lot like the Outright Market Transactions, which focused on the short end of the coupon curve, the purchases were to be neutralized, ostensibly by the sales of another asset, and required the beneficiary country to request it. Conditions were to be attached. If it is the ECB’s tool and it is used under it discretion, won’t that dilute conditionality? Selling German Bunds might make sense if the ECB thought that a shortage of them was an important factor driving the spread. However, determining what is an irrational move can be an expensive exercise.
The euro traded a little above $1.06 yesterday, its best level of the week amid what appeared to be a short squeeze. Earlier in the session it traded below $1.04. The narrowing of intra-EMU bond spreads seemed to encourage the move. The US 2-year premium over Germany fell from 213 bp to 194 bp yesterday, its least in four months. The euro is consolidating today after advancing for the past three sessions, the longest advance this month. It briefly traded below $1.05 in late Asian turnover, where options for 1.2 bln euros expire today. It settled last week near $1.0520. Sterling rallied by nearly 3% over the past two sessions, its biggest two-day rally this year. It poked above $1.24 yesterday but was unable to sustain the strong upside momentum. Sterling has been capped today around $1.2365 as a consolidative tone is seen ahead of the weekend. Initial support is seen around $1.2250, and a break could spur another half cent decline. Sterling settled near $1.2315 last week.
Although Fed Chair Powell pushed back against any suggestion that the economy is fragile, the latest string of May and June data have disappointed. It actually began with the June Empire State manufacturing survey (-1.2 vs. 2.3 median forecast in Bloomberg survey), and carried through May retail sales, and yesterday’s news of a 14.4% drop in housing starts (which partly was blunted by a revision to the April series to 5.5% from -0.2%). The Philadelphia June survey unexpectedly fell to -3.3 from 2.6. The six-month outlook for orders, ostensibly a lead indicator, fell sharply to levels associated with economic contractions. Weekly initial jobless claims were a little higher than expected have averaged 230k over the last couple of weeks, the most in five months.
On tap today are the May industrial production and Leading Indicators Index. Industrial output likely slowed after the heady 1.1% gain in April. Economists expect a modest gain (0.4%) with manufacturing output growth slowing to 0.3% (from 0.8%). The manufacturing sector added 18k jobs in May, according to the recent employment report, the least since April 2021. Given the recent track record of not appreciating the economic softness, the risk is on the downside. The components of the LEI are largely known, and the index is expected to have fallen for the second consecutive month for the first time since Covid struck. Powell makes opening remarks at a conference between the equity market today, and Governor Waller discusses monetary policy tomorrow at a Dallas Fed gathering.
Canada reports May industrial prices and April securities transactions, neither are typical drivers of the Canadian dollar. The swaps market is strongly leaning toward a 75 bp hike at the July 13 Bank of Canada meeting. Several Canadian banks have switched and now look for a 75 bp move. The market has 200 bp of tightening priced in the next four meetings. It looks like a 75 bp move, two 50 bp moves and a 25 bp in December. However, the broader risk appetite seems more important for the day-to-day movements. Since almost reached CAD1.30 in the middle of the week, the US dollar has consolidated. The Canadian dollar did not take part in yesterday’s wider move against the greenback. A break above CAD1.30 targets last month’s high near CAD1.3075. Important support has developed around CAD1.2860. The Canadian dollar is one of the weakest of the major currencies this week, falling about 1.5% against the US dollar. So far today, the dollar trading between MXN20.30 and MXN20.50. It settled near MXN19.96 last week. Mexico’s central bank meets on June 23. A 75 bp hike is expected after four 50 bp hikes and the Fed’s large move. A 100 bp hike seems more likely than a 50 bp move.
Bannockburn Global Forex