Focus turns to BoC policy update after BOJ triggers pick-up in FX volatility

USD: Fresh YTD highs for the US dollar after BoJ policy update

The US dollar extended its rebound yesterday resulting in the dollar index rising to a fresh year to date high at 103.82 although it has since given back some of those overnight. There was no clear fundamental trigger for the extension of the US dollar rally yesterday which was not backed up higher US yields. The more volatile trading conditions in the FX market were encouraged by yesterday’s BoJ policy update which initially triggered a rally for the yen but it has proven to be short-lived. USD/JPY fully retraced the initial move lower and rose r to a high yesterday at 148.70 after hitting a low of 146.99 in the initial aftermath of the BoJ policy update. As we highlighted in yesterday’s FX Daily Snapshot report (click here), the updated guidance has made us more confident that the BoJ will exit negative rate policy in April unless the upcoming spring wage negotiations disappoint expectations. One can’t completely rule out either the possibility that the BoJ could begin to raise at the next meeting in March although it is less likely in our view. It has triggered a sharp adjustment higher in Japanese yields. The 10-year JGB yield hit a year to date high overnight at 0.75% and now stands almost 20bps higher than the low from earlier in the month. The upward  adjustment in Japanese yields is comparable in size to the recent adjustment in US yields. The 10-year US Treasury yield currently stands around 20bps higher than the low from 12^th January. If Japanese yields continue to adjust higher ahead of the BoJ’s next policy meeting in March, the developments should offer more support the yen which has fallen back closer to last year’s lows. However, the move higher in Japanese yields is currently being offset by the recent hawkish repricing of the US yield curve which is dampening the bullish impact on the yen from the BoJ’s policy update. For USD/JPY to come back under renewed downward pressure in near-term, market participants would have to become more confident again that the Fed could begin to cut rates in March which is currently priced at around a 50:50 probability.

The other main development that had an impact on FX market performance yesterday was a report from Bloomberg stating that Chinese policymakers are considering a package of measures to help stabilize their domestic equity market. According to the report, policymakers are considering mobilizing about CNY2 trillion of funds from the offshore accounts of Chinese state-owned enterprises to purchase shares onshore through the Hong Kong exchange link. In addition, at least CNY300 billion of local funds could to utilized to purchase shares onshore. Some of the measures under consideration could reportedly be announced as soon as this week. There has been no official confirmation but there have been indications recently that domestic policymakers are becoming more concerned by ongoing equity market weakness including a pledge for “forceful” measures from Premier Li Qiang. Building investor concerns over the health of China’s economy alongside the ongoing sell-off in Chinese assets has contributed to Asian currencies underperforming at the start of this year. The THB, KRW and MYR are all amongst the worst five performing EM currencies so far in 2024. In order to provide more support for growth in China, the PBoC has just announced that they will cut the reserve required ratio by 0.50 point on 5^th February that they expect to release CNY1 trillion of funds into the economy.       

SOFTER CAD AHEAD OF BOC POLICY UPDATE

Source: Bloomberg, Macrobond & MUFG GMR

CAD: Core inflation pick-up argues against earlier BoC cuts

The BoC will hold their first policy meeting of 2024 today. The BoC are expected to leave their policy rate on hold at 5.00% for the fourth consecutive policy meeting. Market attention will focus on the BoC’s updated policy guidance to see if they provide further clarity over the potential timing of the first rate cut. The Canadian rate market is  currently anticipating that the BoC will start to cut rates just after the Fed, and deliver less rate cuts this year. The first 25bps rate cut is not fully priced in until the June policy meeting, although there are around 17bps of cuts priced in by the April policy meeting. For the year as a whole, the Canadian rate market is pricing in around 95bps of cuts by the end of this year. In comparison, the first 25bps cut from the Fed is fully priced in by May and there are around 138bps of cuts priced by the end of this year.

The BoC’s recent policy guidance has signalled clearly that they still “need to see more downward momentum in core inflation” before they are willing to begin cutting rates. In a key note speech on 15^th December, Governor Macklem stated that it was “still too early to consider cutting our policy rate”. Since Governor Macklem’s speech and the BoC’s previous policy meeting on 6^th December, two Canadian CPI reports for November and December have been released. The reports revealed that core inflation picked up at the end of last year which should make the BoC reluctant to discuss rate cuts as at today’s policy meeting. If that proves to be the case it could disappoint market expectations for earlier BoC cuts and encourage a stronger Canadian dollar. However, we expect any upside for the Canadian dollar to be only modest. Any gains for the Canadian dollar could be tempered if there are discussions by the BoC about scaling back quantitative tightening.              

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
FR	08:15	French Manufacturing PMI	Jan	42.5	42.1	!!
FR	08:15	French S&P Global Composite PMI	Jan	45.2	44.8	!
FR	08:15	French Services PMI	Jan	46.0	45.7	!!
GE	08:30	German Composite PMI	Jan	47.8	47.4	!
GE	08:30	German Manufacturing PMI	Jan	43.7	43.3	!!
GE	08:30	German Services PMI	Jan	49.5	49.3	!!
EC	09:00	Manufacturing PMI	Jan	44.8	44.4	!!
EC	09:00	S&P Global Composite PMI	Jan	48.0	47.6	!!
EC	09:00	Services PMI	Jan	49.0	48.8	!!
UK	09:30	Composite PMI	--	52.2	52.1	!!!
UK	09:30	Manufacturing PMI	--	46.7	46.2	!!!
UK	09:30	Services PMI	--	53.2	53.4	!!!
UK	11:00	CBI Industrial Trends Orders	Jan	-23	-23	!!
US	14:45	Manufacturing PMI	Jan	47.9	47.9	!!!
US	14:45	S&P Global Composite PMI	Jan	--	50.9	!!
US	14:45	Services PMI	Jan	51.0	51.4	!!!
CA	14:45	BoC Rate Statement	--	--	--	!!
CA	14:45	BoC Interest Rate Decision	--	5.00%	5.00%	!!!
CA	15:00	BoC Monetary Policy Report	--	--	--	!!
CA	16:00	BOC Press Conference	--	--	--	!!

Source: Bloomberg