USD/JPY renewed focus as carry appetite persists

JPY: Showing some safe-haven characteristics?

It’s a well-known that since the global inflation shock unfolded in late 2021 into 2022, the yen’s negative correlation with assets and risk-off has broken down. There are a whole host of factors behind this but at its root were two factors – the unprecedented low level of the policy rate and real yields in Japan that turned deeply negative. Secondly, the positive correlation between US yields and risk assets also broke down with higher US yields coinciding with equity market falls (during the inflation shock). So risk-off episodes increasingly involved higher yields and hence USD/JPY failed to decline as was the norm previously.

Yesterday’s price action was a bit more reminiscent of the past! USD/JPY dropped as UST bond yields declined but more in circumstances of what looked like fears over demand weakness with US equities and commodity prices also down notably. The Bloomberg Commodity Index was  down 5% in five trading days – the largest drop in that period since September 2022.

The 2-day drop in USD/JPY totalled 1.55% yesterday and was in fact the largest since December (when the recent intervention is excluded) last year when USD/JPY was falling sharply due to easing US inflation fears and a liquidation of short JPY positions by Leveraged Funds. This move in US yields (10yr -28bps in four days) looks more growth concerns driven than inflation optimism. The ISM Manufacturing index on Monday was much weaker and the JOLTS data yesterday saw job opening drop close to 8mn, the lowest since early 2021 – job openings are now not far from fully retracing the post-covid surge. The yen has weakened back today possibly on relief that the wage data from Japan was not stronger and on US yields stabilising but the price action yesterday in particular was still notable.

While US yields and the Fed will play a bigger role in instigating a turn and a drop in USD/JPY, the BoJ could soon be playing some role. Consistent with our view, Bloomberg reported citing “people familiar with the matter” that the BoJ was considering a change in the current JGB buying policy which has the BoJ buying approx. JPY 6trn per month. A slowdown in JGB purchases would likely mean JGB holdings on the balance sheet of the BoJ would start to decline. A drop to JPY 5trn was mentioned. We will closely monitor whether we get a similar type story from Nikkei in the days leading into the meeting next Friday – a scenario that would provide added credibility to the Bloomberg story.

The sharp drop in commodity prices, the weaker US data and the underperformance of EM FX look like the early signs of a deleveraging of risk positions. The move in EM may be aided by the political uncertainties linked to elections in India, Mexico and South Africa. Nonetheless, further weak US data, in particular on Friday when the NFP data is released would likely reinforce this yen buying and prompt a decline larger than generally expected at this stage of the monetary policy cycles in Japan and the US.

10YR US-JP YIELD SPREAD DROPPING SHARPLY – IN MAY THE JGB 10YR YIELD JUMPED 19BPS & THE UST BOND 10YR YIELD DROPPED 18BPS

Source: Macrobond & MUFG GMR

CAD: BoC to ease

The focus today will be on the Bank of Canada’s monetary policy announcement at 14:45 BST. We expect the BoC to cut the key policy rate by 25bps to 4.75%. The market has come around to this view over recent weeks with the OIS market pricing over an 80% probability of a rate cut.

The most recent catalyst for the increased expectations of a rate cut was the GDP data on 31^st May, which was weaker than expected. The 1.7% Q/Q SAAR was weaker than expected although the details indicated still strong domestic demand conditions with weakness more evident in changes in inventories. The more notable element of the release was the downward revision to the Q4 data from 1.0% to just 0.1%. Annual GDP growth of just 0.6% confirms that the Canadian economy is running well below full capacity. Clearly, the economy is weakening more than assumed by the BoC and this provides the justification to respond to the better inflation data of late.

The average of the BoC’s trimmed and mean annual CPI rates has now declined to 2.75%, the lowest since June 2021 with the CPI data in April and May declining and both were slightly weaker than market expectations. Governor Macklem in April stated that the BoC wanted to see further evidence of inflation easing before being confident to cut. We believe the BoC has that evidence now.

The BoC moving ahead of the Fed can of course be managed by a communication that emphasises caution ahead of lowering rates again – which is a probable strategy adopted today if the BoC does cut. The 2-year swap spread is currently trading at around the same level as back in 2018-19 when the BoC’s policy rate was last 75bps under the Fed’s policy rate so the market appears reasonably well priced for a cut today. Still, the rates reaction will be more about the rhetoric and while we see a cautious message, over the near-term there is scope for a pop higher in USD/CAD especially if crude oil falls further and we see risk-off trading conditions like yesterday. However, any CAD selling should be moderate in our view especially given the building evidence of a slowing US economy.

2-YEAR US-CA SWAP SPREAD VERSUS USD/CAD

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
FR	08:50	French S&P Global Composite PMI	May	49.1	50.5	!
FR	08:50	French Services PMI	May	49.4	51.3	!!
GE	08:55	German Composite PMI	May	52.2	50.6	!!
GE	08:55	German Services PMI	May	53.9	53.2	!!
EC	09:00	S&P Global Composite PMI	May	52.3	51.7	!!
EC	09:00	Services PMI	May	53.3	53.3	!!
UK	09:30	Composite PMI	May	52.8	54.1	!!!
UK	09:30	Services PMI	May	52.9	55.0	!!!
EC	10:00	PPI (YoY)	Apr	-5.1%	-7.8%	!
EC	10:00	PPI (MoM)	Apr	-0.6%	-0.4%	!
US	12:00	MBA Mortgage Applications (WoW)	--	--	-5.7%	!
CA	12:00	Leading Index (MoM)	May	--	0.19%	!
US	13:15	ADP Nonfarm Employment Change	May	173K	192K	!!!
CA	13:30	Labor Productivity (QoQ)	Q1	-0.2%	0.4%	!
US	14:45	S&P Global Composite PMI	May	54.4	51.3	!!
US	14:45	Services PMI	May	54.8	51.3	!!!
CA	14:45	BoC Rate Statement	--	--	--	!!!!
CA	14:45	BoC Interest Rate Decision	--	4.75%	5.00%	!!!!
US	15:00	ISM Non-Manufacturing Employment	May	--	45.9	!!!
US	15:00	ISM Non-Manufacturing New Orders	May	--	52.2	!!!
US	15:00	Total Vehicle Sales	--	15.80M	15.74M	!

Source: Bloomberg