US CPI report to provide key test of recent USD weakening trend

USD/JPY: BoJ policy speculation & US CPI report to drive direction

The yen has weakened overnight resulting in USD/JPY rising back above the 147.00-level and up to a high of 147.60. The yen continues to be driven by speculation over the outlook for BoJ policy ahead of next week’s policy meeting on 19th March. The latest media report from Bloomberg overnight claims that the BoJ officials are edging closer to raising rates and will decide whether to move this month at next week’s policy meeting, with the outcome currently “too close to call” according to people familiar with the matter. The report states that the final decision will be made after officials see the initial tally from spring wage talks that are due to be released on Friday. A strong result could create the final push for a rate increase in March even as some BoJ members retain the cautious view that the bank should wait until April to see more data. Officials are reportedly preparing both for a hike or a hold decision next week although the assessment of officials is that the BoJ is close to liftoff. Some officials believe that with the decision expected to be close, it may come down to Governor Ueda to decide in the end with consensus likely to build around his view. It remains our view that results from wage negotiations announced this week should provide the green light for the BoJ to begin tightening monetary policy next week. Last week’s Rengo wage demands for an average wage increase of 5.85% compared to 4.49% a year ago has already provided further evidence that wage growth is likely to be as strong if not stronger in the upcoming fiscal year. In our latest FX Weekly report (click here), we recommended new short CHF/JPY trade recommendation in anticipation that the yen will initially strengthen if the BoJ tightens policy next week. The latest IMM positioning report revealed that short yen positions held by Leveraged Funds remained elevated at close to their highest levels since 2018 which continues to pose the risk of a short squeeze.

The performance of USD/JPY will be driven as well today by the release of the latest US CPI report for February. After the upside inflation surprise in January, the February CPI report could prove even more important for Fed rate cut expectations and the US dollar. Another upside inflation surprise at the start of this year would more seriously challenge the Fed’s outlook for inflation to continue to slow. Looking back at the performance of USD/JPY just after the release of US CPI reports, there has been a clear trend for USD/JPY to strengthen in recent months. USD/JPY has risen in the first hour after the last three US CPI report releases by an average of +0.57%. The biggest move was after the last US CPI report released in February when USD/JPY rose by +0.73%. The Bloomberg consensus forecast is expecting core CPI to increase by 0.3%M/M in February after the firmer print of 0.4%M/M in January which would bring it back more into line with the average rate during the 2H of last year.

JPY SHORTS REMAIN ELEVATED AHEAD OF BOJ POLICY MEETING

Source: Bloomberg, Macrobond & MUFG GMR

EM FX: Broad-based USD sell off providing relief for EM FX

Emerging market currencies have rebounded over the past week as the USD has continued to weaken more broadly. The best performing emerging market currencies since last Monday have been the PEN (+2.2% vs. USD), ZAR (+2.0%), PLN (+1.7%), and KRW (+1.6%). In contrast, the TRY (-1.4% vs. USD), BRL (-0.6%) and ARS (-0.4%) were the only three emerging market currencies to weaken against the US dollar. Emerging market currencies have been benefitting from the recent correction lower for the USD and US yields. It has been the sharpest USD sell-off since the end of last year. The semi-annual monetary policy testimony from Fed Chair Powell has provided some reassurance that the Fed remains on track to begin lowering rates and is not over reacting to the pick-up in inflation at the start of this year. He indicated that the Fed wants to see a bit more data to confirm that inflation is continuing to slow before having enough confidence to lower rates. The US rate market has moved to price in a total of closer to 100bps of cuts by the end of this year. The key test in the week ahead will be the release today of the latest US CPI report and PPI report on Thursday. A second consecutive month of stronger inflation would be harder of the Fed to look through and challenge market expectations for Fed rate cuts. It poses the main downside risk to further EM FX gains in the week ahead.

The best performing EM EMEA currencies over the past week have been the ZAR and PLN. After failing to break higher above 19.400 at the end of last month, USD/ZAR has fallen back toward support from the 200-day moving average at around 18.700. Market participants had priced in a higher risk premium into the ZAR in the run up to and following last month’s budget in South Africa, which has been pared back so far this month. The current low volatility market environment remains favourable for high yielding currencies such as the ZAR by encouraging carry demand. Three-month USD/ZAR historical volatility has fallen to multi-year lows at the start of this year. At the same time, the PLN is threatening to regain upward momentum. EUR/PLN is currently attempting to break decisively below support at the 4.3000-level which has held since late last year. The low point for EUR/PLN prior to the negative COVID shock in early 2020 was set at just above the 4.2000-level. PLN strength has been encouraged by the NBP. Governor Glapinski noted last week that policymakers were “pleased” by the stronger PLN while adding that the Polish government’s recent deal to unlock access to nearly USD65 billion of EU funds may result in the PLN strengthening further. The stronger PLN is helping the NBP to fight inflation. Unlike other regional central banks and the ECB, the NBP remains reluctant to cut rates this year which is proving a further bullish tailwind for the PLN from a yield spread perspective. If the government restores a 5% VAT on food, the NBP will be more wary of inflation picking up in 2H 2024. Please see our latest EM EMEA weekly (click here) for more details.

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
US	10:00	NFIB Small Business Optimism	Feb	90.5	89.9	!
EC	10:00	Eurogroup Meetings	--	--	--	!!
UK	11:00	BoE MPC Member Mann	--	--	--	!!
US	12:00	OPEC Monthly Report	--	--	--	!!
US	12:30	Core CPI (MoM)	Feb	0.3%	0.4%	!!!
US	12:30	CPI (MoM)	Feb	0.4%	0.3%	!!!

Source: Bloomberg