Yen quickly gives back initial BoJ policy update gains

JPY: BoJ steps into JGB market to slow pace of mover higher in yields

The yen has weakened during the Asian trading session resulting in USD/JPY rising back up to the 142.00-level. The yen has now fully reversed all of the initial gains following the BoJ’s decision to make YCC policy settings more flexible that initially resulted in USD/JPY falling close to the 138.00-level. The boost to the yen from the BoJ’s decision to allow the 10-year JGB yield to move above the previous cap of 0.5% has proven to be short-lived. The 10-year JGB yield has continued to move higher overnight hitting a fresh intra-day high of 0.61% although the ongoing sell-off was dampened by action undertaken by the BoJ. The BoJ unexpectedly announced an unscheduled bond purchase operation highlighting that it can still choose to come into the market at any time and it was likely intended to slow the speed of the move higher in yields. The operation on this occasion was to purchase JPY300 billion of five-to-ten year JGBs at market yields. The announcement of fresh BoJ intervention in the JGB market has reinforced the yell sell-off overnight even as yields have continued to move higher in Japan. 

The more flexible version of YCC clearly does not mean that the BoJ will now take a hands off approach, but it will allow the 10-year yield to move closer to the new hard cap set at 1.0%. The decision by the BoJ to step back in soon though has likely surprised some market participants and  encouraged yen selling overnight. At the same time, the yen’s failure to sustain gains following the BoJ’s policy announcement last week could also reflect the message from the BoJ that it is not in a hurry to begin raising interest rates. Governor Ueda sent a clear signal that adjusting YCC was to make policy easing more sustainable and not a form of monetary tightening. The BoJ wanted to sent a signal that the decision to adjust YCC was separate from any future decision to begin raising interest rates. A decision to raise interest rates will require the BoJ to have more confidence that inflation can be sustained at their 2.0% target. The updated inflation projections showing Japan style core inflation still at 1.6% by the end of the forecast horizon sent a clear signal that the BoJ is not yet ready to raise rates.

The next logical policy step for the BoJ would be to completely remove yield curve control before raising rates out of negative territory when it has more confidence that inflation can be sustained at their 2.0% target. We expect these steps to support our outlook for the a stronger yen in the year ahead although with neither step imminent there is not a compelling case for the yen to strengthen sharply from deeply undervalued levels in the near-term. The modest ongoing move higher in the 10-year JGB yield should though offer more support for the yen.             

CORE US INFLATION PRESSURES SLOWED IN Q2

Source: Bloomberg, Macrobond & MUFG GMR

USD: Showing more resilience to further evidence of slowing US inflation    

The US dollar strengthened modestly last week even after the Fed’s less hawkish than expected policy update at which Chair Powell refrained from strongly signalling that the Fed plans to stick to previous guidance for one further rate hike later this year. The dollar index strengthened by around 0.5% last week. The 10-year US treasury yield has also been threatening to break above 4.0% encouraged in part by the BoJ’s decision to allow the 10-year JGB yield to move higher up towards 1.0%. The less hawkish message from the Fed has been partially offset as well by the ECB’s policy update that sent a stronger signal that they are close to the end of their rate hiking cycle, and the yen’s failure to sustain gains from the BoJ’s policy update.

The US dollar has proven resilient as well to the release on Friday of further evidence of building disinflation pressures in the US. The latest PCE deflator report for June and Employment Costs Index for Q2 both proved to be weaker than expected. The Fed has been closing watching the PCE core services inflation less housing (super core) recently and it remained weak for the second consecutive month in June when it increased by 0.22%M/M. The annual rate of employment cost growth slowed to 4.5% in Q2 down from the peak of 5.1% in Q2 of last year. The data supports our view that the Fed will not raise rates further this year. Ultimately we believe the developments will encourage the US dollar to weaken through the rest of this year but it is proving more resilient for now.

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
NO	09:00	Norges Bank Daily FX Purchases	Aug	--	1000m	!!
UK	09:30	M4 Money Supply YoY	Jun	--	-	!!
EC	10:00	GDP SA QoQ	2Q A	0.2%	-0.1%	!!!
EC	10:00	CPI Estimate YoY	Jul	5.3%	5.5%	!!!
US	19:00	Senior Loan Officer Opinion Survey on Bank Lending				!!!

Source: Bloomberg