USD/JPY renewed focus as carry appetite persists

USD/JPY: BoJ pressure set to build again   

The dollar has rebounded notably against the yen after the 2-year UST note yield jumped 8bps from a low of 4.90% yesterday afternoon, helped by the first increase in US consumer confidence in four months. Still, the rebound did not fully retrace the drop in the previous month and the trend is clearly still pointing lower with inflation continuing to undermine confidence. The 3mth average for consumer confidence hit the lowest level since August 2022.   

Again, market participants appear quick to respond to any sign of stronger data that may flip the Fed from its current stance of waiting for the time to cut rates to potentially pondering the need for a rate hike. The rise in yields yesterday also coincided with Minneapolis Fed President Kashkari speaking although his comments were generally in line with market pricing. He did however state that a rate hike was not ruled out which grabbed attention given the current momentum in the rates market. The OIS market is now only a little over 50-50 priced for a November rate cut with December now the earliest for when at least one full 25bp cut is priced. There is little top tier data today and really only the PCE inflation on Friday can alter the current rates momentum in the market as rate cuts are pushed further back. The jobs data next Friday will be crucial now for determining whether the markets commence the full removal of rate cuts in 2024 or retrace back to an earlier start to rate cuts.

But the move higher in rates has been broad-based globally in May and hence May-to-date has seen the dollar weaken. However, the yen remains under considerable downward pressure with carry appetite elevated due to low FX volatility. EUR/JPY has broken the 170-level on a more sustained basis in recent days for the first time on record while GBP/JPY has broken the 200-level for the first time since 2008.

The BoJ will now be under increasing pressure to respond. The 2-year JGB yield jumped 3bps to reaching 0.37%, the highest level since June 2009 on the back of comments from BoJ Board Member Seiji Adachi who stated that a rate hike was “one option” to deal with yen weakness if it impacts inflation. The BoJ NEER is down close to 8% now from the January high and it will be difficult now for the BoJ not to conclude that yen weakness is lifting inflation more than previously estimated. A July rate hike remains the most likely timing for the next hike – we expect a 15bp increase.

JAPAN’S INFLATION EXPECTATIONS AT HIGHEST LEVEL IN 10YRS AS EXPECTATIONS BUILD FOR ANOTHER BOJ RATE HIKE

Source: Macrobond & Bloomberg

GBP: Breaking higher fuelled to a new post-Brexit high

The pound is continuing to sharply strengthen on a trade-weighted basis with the move now taking the BoE TWI above the closing high recorded in March and to a level not seen since that infamous day on 24^th June 2016 when GBP collapsed after the vote to exit the EU. This could be cited as evidence of market participants embracing the end of the Conservatives time in power and a welcome of a new Labour government but in all likelihood this is more about yield! We continue to see a build-up of evidence pointing to a real GDP recovery that is more robust than expected as the UK finally works though the energy price shock from 2022-23. The latest positive economic data was the CBI Distributive Trades Survey that indicated a notable rebound in reported retail sales in May after the very weak data during a very wet April. The Volume of Sales index jumped from -44 to +8 – the highest level since December 2022. The Orders Placed index had its biggest one-month jump since September 2019.

Inflation is clearly helping here. The Reported Selling Price for retailers came down sharply in May (as can be seen above; quarterly data) from 54 in February to 20 in May – it was the second largest drop on record, surpassed only in the three-month period after the pandemic struck in 2020. This development is going to increasingly result in better sentiment data and then better economic data.

The longer the BoE wait for underlying services inflation to come down, the more investors may anticipate future higher real yields as overall inflation reverts more to price stability levels. This happening in the context of better incoming economic data is a positive backdrop for the pound over the short-term. Earlier yesterday, the BRC shop-price data reinforced this better inflation backdrop with retail inflation in the first week of May falling to just 0.6%, the weakest level since toward the end of 2021. All UK retail inflation is in food (3.2% YoY) with non-food now in deflationary territory at -0.8% - good news for UK consumers that may start to feel more clearly a rise in real incomes.

In these circumstances, GBP could well draw in more carry interest given the continued very low FX volatility. There is a wide (and correct in our view) consensus that the UK election will not be a source of increased uncertainty and volatility which would possibly compromise carry demand. We have abandoned our call for a June rate cut after the CPI data for April and the general election also now makes a June cut very unlikely. We believe the BoE will cut in August but a window has now opened that could see GBP continue to perform well. In addition to the BoE TWI breaking to new post-Brexit highs, GBP/JPY yesterday broke through the 200-level again to reach a high not seen since just before the onset of the GFC – a good signal of increased carry demand.

UK RETAILERS REPORT THE SECOND LARGEST DROP IN SELLING PRICES ON RECORD SURPASSED ONLY AT THE START OF COVID IN 2020

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian Business Confidence	May	88.1	87.6	!
IT	09:00	Italian Consumer Confidence	May	96.0	95.2	!
SZ	09:00	ZEW Expectations	May	--	17.6	!!
EC	09:00	M3 Money Supply (YoY)	Apr	1.3%	0.9%	!
EC	09:00	Loans to Non Financial Corporations	Apr	--	0.4%	!
EC	09:00	Private Sector Loans (YoY)	--	0.4%	0.2%	!
IT	10:00	Italian Trade Balance Non-EU	Apr	--	5.60B	!
US	12:00	MBA Mortgage Applications (WoW)	--	--	1.9%	!
GE	13:00	German CPI (YoY)	May	2.4%	2.2%	!!
GE	13:00	German CPI (MoM)	May	0.2%	0.5%	!!!
GE	13:00	German HICP (YoY)	May	2.7%	2.4%	!!
GE	13:00	German HICP (MoM)	May	0.2%	0.6%	!!
US	18:45	FOMC Member Williams Speaks	--	--	--	!!
US	19:00	Beige Book	--	--	--	!!

Source: Bloomberg