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Macro - Revised monetary policy forecast: Now seeing BoJ wind down NIRP in January 2024

• We have revised our baseline scenario for BoJ monetary policy and now see both YCC and NIRP being discontinued at January 2024 meeting.
• Bank is growing more confident in ability to achieve "virtuous cycle" of wages and prices, with September Tankan providing further support.
• BoJ can no longer ignore risk of excessive currency weakness upsetting price stability.

US Fixed Income: L/T rates are tightening FCI

Macro View: September data, although relatively strong, likely marked the peak in US economic activity (on the backs of a massive fiscal impulse over the summer). In addition, the composition of US data has been mixed (which often happens when the economy is about to inflect). With higher energy prices (further draining savings), the return of student loan payments (which many argue saps consumer demand on the retail sales side), higher rates across the curve and now more geopolitical uncertainty, the US economy will likely start to weaken again in Q4 and Q1 next year.

Fed Policy: Given that the recent minutes from the September FOMC meeting highlighted that there are “2-way risks” in the form of, balancing the high inflation versus the impact of potentially increasing job losses by going too far with tightening, this along with more dovish rhetoric from most Fed speakers, we argue this is another piece of guidance that suggests that the Fed hiking cycle is over (which has been our view since the last hike in July) and that their focus is turning to keeping rates “higher for longer.”  In addition, they will likely turn to using the long-run dot to convey that, if and when they cut, they are going to try to avoid going to ZIRP.

Rates View: It’s been our view that the bear steepener would do the last leg of the tightening for the Fed as long-term rates partially normalize higher. The 10yr has risen roughly 150bps from the lows this year. Such a move has more of an impact on the financial conditions index (FCI) than if the Fed had raised rates by a similar amount (in all fairness these long-term rates should have had a stronger beta and tracked the Fed Funds higher but other forces were at play) due to it hurts the most interest-rate sensitivity sectors of the economy (such as housing, large corporates etc).

FX Outlook

The US dollar on a DXY basis has been on a steady path of appreciation through the latter part of the summer. In fact on a DXY basis, the dollar has gained for ten consecutive weeks, a record period. In that sense, we should become a little more wary over the sustainability of the momentum to the upside. A lot of negative sentiment is now reflected in the price of currencies versus the US dollar. On an RSI-basis, the DXY index is trading close to the 70-level and exhaustion could set in quickly if there is any change in the relative macro backdrop. Our forecasts assume there is no further rate increases from the Fed but the risks are high and if the data remains resilient, a November hike is feasible which will likely see the dollar advance further. Still, the scope for a sustained move stronger we believe is limited from here. Slowing consumer spending in the US, a continued weakening of the labour market, and the ongoing transmission of monetary tightening is likely to become more evident and help prompt a reversal of dollar strength.

KEY RISK FACTORS IN THE MONTH AHEAD

• We have maintained the current range for USD/JPY given the limited move in spot since our last publication. The move higher in yields however does point to a greater risk to a move higher for USD/JPY. Higher energy prices due to the Hamas-Israel conflict in the Middle East is another negative for the yen that could spark a move higher. The main risk to that view would be more aggressive intervention than anticipated that turns USD/JPY sustainably lower, possibly helped by a correction lower in US yields, possibly due to increase geopolitical risks globally. That seems less likely over the near-term and it is difficult to see intervention having success in sustainably turning USD/JPY lower without some shift in the fundamental backdrop.
• The main risks to our bearish bias for EUR/USD in the month ahead are: i) market participants are already pricing in US exceptionalism leaving the USD vulnerable to a correction lower if US growth starts to slow more in Q4 and growth outside of the US is not as weak as expected especially in Europe and China, ii) the conflict between Hamas and Israel quickly de-escalates with Israel deciding against a ground operation in Gaza, and/or iii) the ECB proves more sensitive to higher energy prices and signals another hike is likely at the December policy meeting.     
• One upside risk for USD/CNY is that the escalation of Middle East tensions that could boost oil prices and the US dollar, triggering bigger capital outflows from Chinese domestic markets. Also, default risk of China’s property developer Country Garden could trigger intensifying selloffs of Chinese stocks, adding upside pressure for the USD/CNY.