USD wobbles continue into FOMC

USD: Risks persist with outlook darkening

The surge of the US dollar versus the yen toward the end of last week and on Monday plus some broader strength across G10 suggested the dollar was set for a rebound with the FOMC this evening likely to hike rates by another 25bps, taking the key policy rate to 5.00% - 5.25%. But we remain sceptical of that prospect and continue to believe that the outlook is already darkening and hiking into such uncertainty is unlikely to support the dollar in a sustained way.

The three aspects that are clouding the outlook for the US remain and helped fuel renewed dollar selling yesterday – the weak US regional banking sector; the weakening economic data and the unresolved US debt ceiling gridlock. The KBW Regional Bank Index fell 5.5% yesterday while the S&P Bank Index was down 3.2%. The Euro Stoxx Bank Index fell 2.4%. US banks continue to be viewed by investors as more problematic and higher risk. The complete wipe-out for share and bondholders are making investors wary of other regional names and the risk is that this crisis has further to run as deposit flight takes hold elsewhere. The 2yr UST note yield was down close to 20bps which we believe would have warranted a sharper drop for the US dollar more broadly with the FOMC meeting later perhaps limiting the decline at this stage. We covered the FOMC meeting in our FX Weekly (here) and expect a change in communication to a more data-dependent guidance on future policy changes but it is unlikely the FOMC will explicitly signal a pause.

In addition to the increased banking sector concerns we had data that will undoubtedly raise fears of a weaker than expected jobs report on Friday. There is no link between the JOLTS data yesterday and the payrolls on Friday but the data did add to the list of evidence that the labour market is weakening. Job openings declined once again to a 5.8% rate, the weakest since March 2021 and down from a high of 7.4% recorded in March 2022. The Quit rate, which provides a good gauge of the confidence of workers to leave their job declined fell to 2.5%, matching the February low which was the weakest since March 2021. It adds to the data suggesting a softening labour market, which we believe will begin to show up in the official NFP data over the coming months.

Finally, the x-date confirmation by UST Secretary Janet Yellen has brought into focus the looming debt ceiling risk. The assessment that the x-date was “in early June or even 1^st June” means this risk will increase significantly for the financial markets this month. Given the latest assessment of the data, President Biden has invited the four primary leaders of Congress to a meeting at the White House on 9^th May. If no progress is made at that meeting expect the risk premia associated with the debt ceiling to increase notably. For FX that means a weaker US dollar versus core G10.

FIRST REPUBLIC DEAL HAS FAILED TO HALT REGIONAL BANKS DECLINE

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Rebound as risks escalate

The currency pair that will be most sensitive to the outcome of the FOMC tonight will be USD/JPY. The BoJ policy decision and guidance on Friday has encouraged renewed JPY selling with the BoJ the only G10 central bank not considering a change in policy. The yen has weakened on market participants pushing back on the timing of a change in YCC. But it remains difficult to envisage a scenario that is consistent with renewed sustained yen selling from here. If changing YCC is a plausible relevant risk (higher inflation in Japan) then speculation is likely to resume quite quickly from here and that will limit further selling.

If inflation falls back globally and in Japan then YCC is more irrelevant as a policy in any case and the circumstances of that scenario (falling yields) is likely to be weaker growth, increased recession risks and/or risk aversion. In that scenario we see the yen strengthening, just like what unfolded yesterday. Price action suggests to us that the surge in USD/JPY post BoJ meeting reflected a position squeeze with plenty of long JPY positions forced from the market on the move higher.  

The market is also under-estimating the substantial improvement in underlying fundamentals for the yen from the decline in energy prices. Natural gas prices for delivery in Japan have dropped to levels not seen since June 2021, so just like for EUR and GBP, this terms of trade improvement will result in considerable benefits for JPY. The above chart highlights the overshoot of USD/JPY relative to Japan’s terms of trade relative to the US. Based on current prices, an annual JPY 10-15trn shrinkage in Japan’s energy trade deficit is feasible.

Finally, there are aspects of the BoJ announcements last week that could get more attention if the yen rebounds further. The “lower rates” guidance was dropped which opens up greater flexibility for policy changes in both directions; Governor Ueda confirmed that a policy change can take place as the policy review is ongoing; and Governor Ueda did confirm Friday that the BoJ could make conclusions of next year’s wage rounds by assessing incoming data before then, highlighting the risk of a sooner policy change.

The idea of a sustained return of the USD/JPY carry trade that results in further rises in USD/JPY lacks credibility to us and we maintain that risks are greater to the downside as we advance toward greater signs of recessionary conditions in the US. We have maintained our short USD/JPY trade view in our FX Weekly (here). It would likely take a very hawkish FOMC outcome this evening to see a sustained rebound in USD/JPY.

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian Monthly Unemployment Rate	Mar	8.0%	8.0%	!
EC	10:00	Unemployment Rate	Mar	6.6%	6.6%	!!
US	12:00	MBA Mortgage Applications (WoW)	--	--	3.7%	!
US	13:15	ADP Nonfarm Employment Change	Apr	148K	145K	!!!!
US	14:45	S&P Global Composite PMI	Apr	53.5	52.3	!!
US	14:45	Services PMI	Apr	53.7	52.6	!!
US	15:00	ISM Non-Manufacturing Business Activity	Apr	54.5	55.4	!!
US	15:00	ISM Non-Manufacturing Employment	Apr	52.6	51.3	!!
US	15:00	ISM Non-Manufacturing PMI	Apr	51.8	51.2	!!!
US	15:00	ISM Non-Manufacturing Prices	Apr	59.9	59.5	!!
US	19:00	FOMC Statement	--	--	--	!!!!!
US	19:00	Fed Interest Rate Decision	--	5.25%	5.00%	!!!!!
US	19:30	FOMC Press Conference	--	--	--	!!!!!
NZ	22:00	RBNZ Financial Stability Report	--	--	--	!!
NZ	23:45	Building Consents (MoM)	Mar	-0.3%	-9.0%	!!

Source: Bloomberg