FX Weekly

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GDP data unlikely to alter BoJ action

FX View:

The yen last week was the worst performing G10 currency and this week was close to repeating that with only the Swiss franc performing worse. Weak GDP data for Q1 has raised doubts over the ability of the BoJ to counter yen weakness through tighter monetary policy while today’s JGB buying operation did not see a further reduction in size following Monday’s cut. However, we lay out reasons why the weak GDP data is unlikely to deter the BoJ from lifting the key policy rate further, probably in July. We also look at commodities and FX highlighting a near-term favourable backdrop for commodity-related FX although mindful of risks later in the year. US dollar weakness has partially reversed today which highlights to us the likelihood of narrow trading ranges continuing with low volatility favouring carry strategies over the near-term.

JPY LAGS AGAIN AS YIELD PLAYS A ROLE IN FX PERFORMANCE

Source: Bloomberg, 14:00 BST 17th May 2024 (Weekly % Change vs. USD)

Trade Ideas:

We have maintained our long EUR/GBP and long EUR/USD trade ideas.

JPY Flows – Balance of Payments : 

We look at the BoP data for March and significantly, Japan current account surplus on a 12mth basis hit a new record of over JPY 25trn fuelled by still high but declining FDI income surplus and a new record portfolio investment income surplus reflecting high fixed income yields.

FX Carry Signals : 

This week our FX carry signals flag long SEK /CHF and long GBP/CHF when monitoring historical performance across a 3-week, 6-week, 9-week period. We analyse the cumulative historical performance of our volatility adjusted carry strategy for both SEK/CHF and GBP/CHF. Over the last 7-month period the strategies have yielded returns of 4.9% and 4.6% respectively.

FX Views

JPY: GDP contraction no barrier to rate hike

The US dollar underperformance this week has played out aligned closely to yield with the New Zealand dollar the top performing G10 currency and the Swiss franc and yen the two worst performing. The dollar is ending the week on a better footing with some moderate recovery after the sell-off driven mainly on Wednesday by the weaker CPI print. The break below technical support should have resulted in further declines for the dollar and this end-of-week performance for the dollar highlights the current lack of conviction in the foreign exchange market that argues against big moves. In such circumstances, carry may dominate which appears to be the view of market participants given the G10 FX performance table this week.

One factor that may have influenced yen performance this week was the disappointing GDP data for Q1. The contraction of 2.0% Q/Q SAAR was larger than expected (-1.2%) and the Q4 data was revised lower from 0.4% to 0.0%. Japanese households continue to suffer and the drop in consumer spending accounted for 80% of the overall contraction in GDP. The yen weakened and the 2-year JGB yield dropped in the aftermath of the data although a rebound in US yields has helped see that JGB yield drop reverse.

There is no doubt the Japanese economy is weak. Real wage have been negative for close to 2yrs and that is obviously weighing on consumer sentiment and spending. But there was one-off factors that reinforced the contraction. Firstly, the earthquake at the start of the year would likely had a marginally negative impact on activity. Secondly, auto production and consumption was hit notably by irregularities in certification tests and was clearly illustrated by the 40.5% plunge in durable goods consumption. However, that issue has been resolved and auto production rebounded 9.6% in March and hence this negative should reverse in Q2. Q1 also saw a very large drop in exports – the 18.7% plunge in exports was the worst since Q2 2020 when the global pandemic struck global demand. Net exports shaved 0.3ppts from Q/Q GDP and is likely to be a one-off as well. So yes, Japan GDP remains weak, but the weakness was exaggerated and a rebound in Q2 looks probable.

It is also worth remembering that in February the government approved a fiscal package that included income and residential tax cuts worth JPY 3.5 trillion that will take effect in June. The government estimated that the total package, worth JPY 17 trillion would help lift GDP by 1.2% each year for the next three fiscal years. The package also incorporated the extension of utility subsidies for households, which was first extended to the end of April and now until the end of May. The removal of the subsidy will lift CPI in June, which will be reinforced in part by the fiscal boost to growth.  

PLUNGE IN DURABLE GOODS CONSUMPTION SET TO REBOUND IN Q2

Source: Bloomberg, Macrobond & MUFG GMR

USD/JPY VS REGRESSION MODEL BASED ON YIELD SPREADS, OIL AND EQUITIES

Source: Bloomberg, Macrobond & MUFG GMR

With inflation undermining growth in Japan similar to what has happened in Europe, the BoJ will likely increasingly view yen weakness as growth negative. In addition to hitting real incomes and therefore consumption, Japanese companies now view a weak yen increasingly negatively. In a report released today from Teikoku Databank, 63.9% of company respondents cited yen weakness has negatively impacting their profits with 35% citing a negative impact on sales. 50.1% of respondents suggested a range in USD/JPY between 110.00-120.00 as desirable for business conditions. This negative impact from yen depreciation makes sense given the shift in Japan’s production overseas and the near 2yrs of negative real wage growth. The clear benefit comes in the tourism sector. Japan tourist arrivals surpassed 3mn in March for the first time ever and maintained a level over 3mn in April again. Of the 10 sub-sections of Japan’s CPI, Recreation & Culture inflation is currently at 7.2%, by far the largest increase, accounting for 25% of the total YoY increase in March despite that section accounting for only 9% of total CPI.

Hence, in our view there are numerous factors that should not curtail the BoJ from hiking rates despite the weak GDP print this week. As highlighted here in recent weeks, the BoJ’s monetary stance in real terms if excessively loose and the policy rate needs to be lifted to reduce this inappropriate stance. The weak real GDP data in part reflects the consequence of the BoJ’s policy stance. The hawkish communication from Governor Ueda last week looks to be having an impact in rates. The 2yr JGB yield has moved higher despite the drop in US yields and the 2yr spread has narrowed by about 30bps since the start of May. USD/JPY has not responded as much as implied by the recent co-movement but we’d expect BoJ communication to be consistent with the recent communications that the virtuous cycle between wages and prices continues to strengthen suggesting the BoJ is on course to hike, potentially in July.

Based on broader FX conditions which points to low volatility and positive performance for carry, the yen could continue to slowly drift weaker. The risk to this however is that the BoJ will signal a growing hawkish stance that could see spreads narrow further and prompt some renewed yen strength.

2YR US-JP SPREAD DECLINE HAS NOT TRANSLATED TO USD/JPY DROP

Source: Bloomberg, Macrobond & MUFG GMR

EQUALLY WEIGHTED G10-JAPAN 2YR YIELD SPREAD VS G10 FX/JPY BASKET

Source: Bloomberg, Macrobond & MUFG GMR

Commodity FX: Assessing risks to the sustainability of recent strength

The commodity-related currencies of the NZD (+1.7% vs. USD), NOK (+1.4%) and AUD (+1.0%)  have been amongst the best performing G10 currencies over the past week. For this month as a whole the NOK (+4.0% MTD vs. USD), NZD (+3.9%) and AUD (+3.1%) are top three performing G10 currencies. In contrast, the CAD (+1.0% MTD vs. USD) has been one of the worst performing G10 currencies with its performance remaining more tightly linked to the USD.

The high beta commodity-related G10 currencies of the AUD, NOK and NZD have benefitted from the improvement in external market conditions so far this month. MSCI’s global equity index has staged a strong rebound and hit fresh cyclical highs this week. The low point for global equity markets last month coincided with US yields and the USD putting in place a near-term peak on 16^th April. The softer US CPI print for April has reinforced the recent improvement in global investor risk sentiment by further boosting optimism over a softer landing for the global economy. It keeps alive expectations for multiple Fed rate cuts later this year and there has already been evidence of stronger growth  at the start of this year in China and Europe. At the same time Bloomberg’s commodity price index has risen to year to date highs creating a more supportive external environment for G10 commodity currencies in the near-term.     

Nevertheless, there remain concerns over the sustainability of stronger growth in China. The release of the latest monthly activity data for April was mixed. While industrial production surprised to the upside when it expanded by 6.7%Y/Y in April, it was offset by weaker than expected growth for retail sales (+2.3%Y/Y) and fixed asset investment (+4.2%Y/Y YTD Y/Y excluding rural). The report will play into building concerns that China could rely more on external demand to drive economic growth while domestic demand remains weak. However, domestic policymakers do appear to be taking a more active stance to provide more support for the housing market which remains an important headwind to growth for domestic demand. The latest package of measures announced included establishing a nationwide program to provide cheap loans to help state-owned companies purchase unsold homes. The PBOC expects the CNY300 billion of loans offered at a rate of 1.75% to result in an estimated CNY500 billion of credit overall. Lenders in the new program will be encouraged to extend financing to regional state-owned enterprises handpicked by local governments to support their purchase of unsold finished homes at reasonable prices. However, the size of the program has come in on the lower side of expectations putting a dampener on China growth optimism. 

G10 COMMODITY CURRENCIES REBOUND

Source: Bloomberg, Macrobond & MUFG GMR

GLOBAL BACKDROP IMPROVING FOR COMMODITY FX

Source: Bloomberg, Macrobond & MUFG GMR

In response to the threat posed by China relying more heavily on ”unfairly underpriced exports” to drive economic growth, the Biden administration has just announced a fresh package on tariffs. National Economic Council Director Lael Brainard stated that “today, at a time when a strong US economic recovery is underway powered by domestic consumption and investment, there are signs that China is exporting its way to recovery…using the same playbook has before to power growth at the expense of others by investing in significant overcapacity and flooding global markets with artificially cheap exports”. The Biden tariffs which will take effect from 2024 and 2026 are more targeted covering USD18 billion of current exports from China. The new tariffs will apply to only around 4% of China’s exports and are intended to create a higher hurdle to prevent China from being able to build their presence in the US market for electric vehicles, batteries, solar cells, semiconductors and critical materials. While the tariff hikes are largely symbolic and will have limited economic impact on China in the near-term, we are wary of the risk that Europe will follow the US. In contrast to the US, Europe accounts for more than a third of China exports of green products and older generation semi-conductors. Another risk is that US could take actions to curb the export re-routing by China through other countries such as auto components in Mexico. Ahead of the US election, we expect investors to remain concerned over the risk of further global trade disruption acting as a dampener on G10 commodity currency performance later this year  

In these circumstances, we believe that the global backdrop has become more supportive for commodity currencies in the near-term. The softer US CPI report for April has provided some much needed relief from market participants and reinforced confidence in a softer landing for the global economy. However, there are still doubts over the sustainability of the recent pick-up in China growth. New steps to stimulate the housing market were on the smaller side of expectations. The Biden tariff annoucement while limited in scope does highlight that trade tensions between the US and China will be an important battle ground ahead of the US elections later this year. For these reasons, we remain cautious over the outlook for G10 commodity currencies beyond the near-term.           

BIDEN TARIFFS ARE TARGETED & SMALL IMPACT

Source: MUFG Capital Markets Strategy

WEAK DOMESTIC DEMAND REMAINS CONERN IN CHINA

Source: Bloomberg, Macrobond & MUFG GMR

Ccy	Date	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
AUD	05/21/2024	02:30	RBA Minutes of May Policy Meeting				!!
EUR	05/21/2024	09:00	ECB Current Account SA	Mar	--	29.5b	!!
EUR	05/21/2024	09:00	ECB's Lagarde Speaks				!!!
CAD	05/21/2024	13:30	CPI YoY	Apr	2.7%	2.9%	!!!
USD	05/21/2024	14:00	Fed's Waller Speaks				!!!
USD	05/21/2024	14:05	Fed's Williams Speaks				!!!
GBP	05/21/2024	18:00	BOE's Bailey Speaks				!!!
JPY	05/22/2024	00:50	Trade Balance	Apr	-¥373.5b	¥366.5b	!!
NZD	05/22/2024	03:00	RBNZ Official Cash Rate		5.50%	5.50%	!!!
SEK	05/22/2024	07:00	Unemployment Rate SA	Apr	--	8.6%	!!
GBP	05/22/2024	07:00	Public Sector Net Borrowing	Apr	--	11.0b	!!
GBP	05/22/2024	07:00	CPI YoY	Apr	--	3.2%	!!!
GBP	05/22/2024	07:00	PPI Output NSA YoY	Apr	--	0.6%	!!
GBP	05/22/2024	13:45	BOE's Breeden Speaks				!!!
USD	05/22/2024	15:00	Existing Home Sales	Apr	4.16m	4.19m	!!
USD	05/22/2024	19:00	FOMC Meeting Minutes		--	--	!!!
NZD	05/22/2024	23:45	Retail Sales Ex Inflation QoQ	1Q	--	-1.9%	!!
EUR	05/23/2024	09:00	HCOB Eurozone Composite PMI	May P	--	51.7	!!!
GBP	05/23/2024	09:30	S&P Global UK Composite PMI	May P	--	54.1	!!!
GBP	05/23/2024	12:30	BOE Chief Economist Huw Pill Speaks				!!!
USD	05/23/2024	13:30	Initial Jobless Claims		--	--	!!
USD	05/23/2024	14:45	S&P Global US Composite PMI	May P	--	51.3	!!
USD	05/23/2024	15:00	New Home Sales	Apr	680k	693k	!!
JPY	05/24/2024	00:30	Natl CPI YoY	Apr	2.4%	2.7%	!!!
GBP	05/24/2024	07:00	Retail Sales Inc Auto Fuel MoM	Apr	--	0.0%	!!!
EUR	05/24/2024	07:00	Germany GDP SA QoQ	1Q F	--	0.2%	!!
EUR	05/24/2024	08:00	ECB's Schnabel Speaks				!!
CHF	05/24/2024	08:45	SNB's Jordan Speaks				!!
CAD	05/24/2024	13:30	Retail Sales MoM	Mar	-0.1%	-0.1%	!!
USD	05/24/2024	13:30	Durable Goods Orders	Apr P	0.3%	2.6%	!!
USD	05/24/2024	15:00	U. of Mich. Sentiment	May F	67.4	67.4	!!

 Source: Bloomberg, Macrobond & MUFG GMR

Key Events:

• The RBNZ will be the latest G10 central bank hold a policy meeting in the week ahead. We expect the RBNZ to leave rates on hold at 5.50% for the seventh consecutive meeting. We expect the RBNZ to indicate that the balance of risks was little changed since their last policy meeting. Headline inflation slowed further to 4.0% in Q1 but less than the RBNZ was expecting while there appears to be more slack in the labour market as the unemployment rate rose by a 0.3ppt to 4.3%. On balance, the fundamental case does not yet justify the RBNZ sending a stronger signal that a rate cut will be delivered soon.
• There is also a heavy schedule of central bank speaker in the week ahead including Fed Vice Chair Williams and Governor Waller alongside the release of the minutes from the 1^st May FOMC meeting. In the UK, BoE Governor Bailey, Chief Economist Pill and MPC member Breeden are scheduled to speak. The comments will be scrutinized closely to assess how close the Fed and BoE are to cutting rates in light of recent developments.
• The main economic data releases in the week ahead will be the latest CPI reports from Canada, the UK and Japan for April. Headline inflation is expected fall sharply in April as the OFGEM energy price cap was reduced by around 13%. Core measures of inflation in the service sector will be more important for the BoE when weighing inflation persistence risks. Further evidence of slowing inflation in Canada in April will be required to bring forward BoC rate cut expectations to the June rather than July policy meeting.