FX Weekly

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JPY boosted by BoJ rate hike speculation

FX View:

The JPY has been the best performing G10 currency over the last week resulting USD/JPY falling back towards support from the 200-day moving average that is located at around 146.20. The JPY has benefitting from market participants bringing forward expectations for the BoJ to lift rates back into positive territory as soon as this month. Further evidence of stronger wage growth in the week ahead should provide the green light for the BoJ to hike this month. When the BoJ exits negative rate policy, we also expect the BoJ to display confidence that it is unlikely to be a one off hike which will be important to encourage a stronger JPY. The move lower in USD/JPY has also been driven by a weaker USD after Chair Powell indicated that the Fed remains on course to cut rates. Another upside inflation surprise in February is the main upside risk for the USD in the week ahead.

BROAD-BASED USD WEAKNESS

Source: Bloomberg, 15:00 GMT, 8th March 2024 (Weekly % Change vs. USD

Trade Ideas:

We are recommending a new short CHF/JPY trade idea, and maintaining our short EUR/GBP trade idea.

JPY Flows:

Since the NISA limits were increased nearly three-fold by the Japanese government from the start of January, we have seen evidence of Japanese households taking advantage of this with increased buying of foreign equities. Investment Trusts bought a further JPY 1,011bn of foreign equities in February, the third largest one-month purchase total on record.

Short Term Fair Value Modelling:

This week we monitor the relationship between spot and fair value for our JPY, GBP and EUR short-term regression models. We identify a convergence in the relationship between GBP/USD and the calculated fair value where GBP/USD is currently overvalued by 0.96%. Whilst our USD/JPY and EUR/USD fair value models identify undervaluations of -1.04% and -2.49% respectively.

FX Views

USD/JPY: BoJ to hike in March

We highlighted here in our last FX Weekly on 23^rd February (here); in our FX Monthly Outlook (here) an ad hoc video released this week (here) that the BoJ was set to hike its policy rate by 10bps at the next meeting on 19^th March. A number of factors this week now make that highly likely. The base earnings data this week were stronger than expected, Rengo – Japan’s Federation of Unions – released its estimate of the wage demand being sought by over 3,100 union in Japan and the 5.85% increase was larger than last year’s 4.49% that resulted in a final increase of 3.58% - that suggests the potential for a wage increase close to 5.0%. We also had communications from the BoJ (Nakagawa) that suggested March was possible and now today we have had a Reuters news story citing “four people familiar with the matter” that the BoJ was leaning toward a rate hike in March. The OIS is now implying close to a 100% probability of an increase and hence in the space of a week has jumped from around a 30% probability to close to 100%. In that sense, we need to focus on potential other aspects of a policy announcement at the week on 19^th March.

The first aspect will the communication. We see it as unlikely that the BoJ would signal a move as being a one-off. More likely would be to highlight the significance of a rate hike in signalling the end of the multi-decade period of mild deflation. We expect a second rate increase in Q4 although the meeting on 20th September is very feasible. The second aspect is whether there’s a policy change in regard to the balance sheet. JIJI Press reported today that the BoJ would replace YCC with a plan to purchase JPY 6trn JGBs per month. On this second aspect we are not as sure and still believe there’s a good chance that the YCC is policy is maintained and the focus remains on the removal of NIRP/ZIRP initially. Even if however a YCC policy change is announced and if a target level (say of JPY 6trn per month) is announced we are sure the BoJ would caveat that with a degree of flexibility by emphasising a willingness to buy more.

A March rate hike is now a lot better priced than even just a week ago but the yen carry trade became very popular again since the turn of the year and with FX vol being so low of late has encouraged the trade even more. Last week we saw a surge in speculative yen selling and if the BoJ hikes, signals more to come and potentially addresses balance sheet policy as well, we see scope for USD/JPY to continue reversing the rally from 140.00 since the start of this year.

BOJ JGB BUYING HAS SLOWED TO AROUND JPY 6TRN

Source: Bloomberg, Macrobond & MUFG GMR

SURGE IN YEN SHORTS TO LARGEST LEVEL SINCE 2018

Source: Bloomberg, Macrobond & MUFG GMR

G10 FX: ECB & Fed moving closer to cutting rates ahead of the BoE

The major foreign exchange rates have finally broken out of the tight trading ranges that had been in place in recent weeks. The pick-up in foreign exchange market volatility this week has been mainly driven by the USD which has gained downward momentum. The dollar index has closed lower for five consecutive trading days with the sell-off accelerating after support from the 200-day moving average was broken at around 103.70. Downward momentum for the USD is the strongest since the end of last year. USD weakness has been encouraged by Fed Chair Powell’s semi-annual testimony to Congress in which he remained confident that the US economy was heading for a soft landing. There was no indication that the Fed was overly concerned by the pick-up in inflation in January, and there appears to be a low hurdle for the Fed to begin rate cuts. He stated that “we’re not far” from having the confidence to begin dialling back the level of policy restriction, and that “let’s see a little bit more data so we can become confident”. The release in the week ahead of the US CPI and PPI reports for February will provide an important test to the Fed’s view that the inflation pick-up at the start of this year is likely to be temporary. Another upside inflation surprise poses the main risk to USD weakness extending in the week ahead.

The timing of the first Fed rate cut still appears likely to be closely aligned to the timing of the first ECB rate cut which is contributing to the relative stability of EUR/USD. The ECB’s policy update (click here) signalled that they are preparing the ground to begin cutting rates in June. Another downward revision to the ECB staff forecasts for inflation indicated that upside risks to the ECB’s inflation target have eased further. With the updated forecasts showing both headline and core inflation falling back to their target in the coming years and economic growth expected to remain well below potential this year, it is becoming harder for the ECB to justify keeping the policy rate at the current restrictive level. President Lagarde indicated in the press conference that they would have a lot more information available in June compared to in April to assess if inflation and wage growth has slowed further at the start of this year. As a result, we continue to expect the first rate cut in June but an earlier start in April can’t be completely ruled out.  The risk of an earlier cut has since been lifted by comments today from Governing Council members Villeroy de Galhau and Rehn who both indicated that April is a live meeting. The developments support our short EUR/GBP trade idea which is built on the assumption that the ECB will begin cutting rates ahead of the BoE.

The developments continue to favour GBP outperformance in the near-term. So far this year the GBP has been the best performing G10 currency. The release of the latest UK labour market and January GDP reports are the main event risks for the GBP in the week ahead. A faster slowdown in wage growth and/or negative GDP growth is needed to bring forward BoE rate cut expectations from August.

GBP IS BREAKING HIGHER VS. BASKET OF EUR & USD

Source: Bloomberg, Macrobond & MUFG GMR

EUR/GBP SET TO RETEST SUPPORT AT 0.8500-LEVEL

Source: Bloomberg, Macrobond & MUFG GMR

Weekly Calendar

 Source: Bloomberg, Macrobond & MUFG GMR

Key Events:

• The main economic data releases in the week ahead will be from US including the latest CPI report for February (Tues) and retail sales report for February (Thurs). After inflation picked up in January, market participants and the Fed will be watching closely to better assess if the strong inflation at the start of this year is likely to prove a temporary. So far the Fed has largely downplayed the inflation pick-up in January as a bump in the road which followed the marked slowdown in 2H of last year. Core CPI increased by an annualized rate of 3.6% in the six months to the end of January. The Fed’s view that inflation is likely to slow further would be more seriously challenged if inflation proved to be stronger for the second consecutive month in February. The USD has strengthened initially following the release of the last three US CPI reports.

• In addition, the release of the latest US retail sales for February will attract more attention in the week ahead. After the retail sales report for January revealed much weaker than expected spending at the start of this year, the February report will provide a better indication over the likely scale of the slowdown in consumer spending in Q1. After expanding robustly by an annualized rate of just over 3.0% in 2H of last year, the current Bloomberg consensus forecast is expecting consumer spending to slow closer to 2.0% in Q1.

• The main economic data release in Europe in the week ahead will be the latest UK labour market report. Even though the UK economy fell into technical recession in the 2H of last year according to the current data released the labour market has continued to prove relatively resilient with the number of unemployed continuing to decline which is unusual during an economic downturn. The BoE would like to see more signs of weakening momentum in the UK labour market including slower wage growth to give them more confidence to begin lowering rates. A sharper slowdown in wage growth in the week ahead would encourage market expectations for an earlier BoE rate cut.