FX Weekly
- Jun 14, 2024
To read the full report, please download PDF.
EUR downside risks prevail
FX View:
The financial markets this week are closing out in risk-off mode with European equities leading a move lower as a political risk premium is built in further ahead of the first round of French elections on 30th June. The OAT/Bund spread has shot through the energy-shock and pandemic wides to hit levels not seen since the 2017 presidential elections. The selling has helped limit yen selling after the BoJ meeting today with Governor Ueda pre-announcing a JGB buying reduction plan at the next meeting in July. We see external factors as being more supportive for the yen over the coming weeks. The focus next week will shift to the UK with the key CPI report followed by the BoE meeting. A replication of the May vote (7-2) seems most likely although similar to the Fed this week, the CPI report ahead of the meeting could play a role. Our main FX takeaway is we should be braced for further EUR falls as the political risk premium likely increases.
EUR & JPY SUFFERS ON POLITICAL RISK & BOJ CAUTION
Source: Bloomberg, 13:00 BST 14th June 2024 (Weekly % Change vs. USD)
Trade Ideas:
We were premature in looking to buy MXN after the election uncertainty and this position vs ZAR has been cut. In order to capture the potential for increased political risk premium, we have opened a short EUR/JPY trade.
JPY Flows – Portfolio, by investor type :
The monthly MoF flow data for May revealed a rebound in foreign bond buying driven mainly by Japanese banks. Investment Trust buying of foreign equities continued a record pace with the annualised pace over JPY 12trn. NISA expansion continues to impact JPY.
FX Correlation Trees: :
This week our correlation tree identified an uncommonly strong correlation between USD/JPY and USD/CHF (0.83), this is the strongest 30-day correlation between the currency pairs since April 2020 during the worst part of the covid-19 shock and representative of a time when the JPY exhibited typical safe-haven characteristics.
FX Views
JPY: BoJ caution on show but July hike still on
The yen has weakened today on the back of the BoJ decision to pre-announce rather than announce a change to its JGB buying plans. The 10-year JGB yield peaked at 1.10% in May on the speculation of a change at today’s meeting but has declined in line with UST bond yields and today has fallen to level not seen since early May. Still, the 10-year yield drop today was just 3bps. The pre-announcement does however mean that the JGB purchase slowdown will take place but from a meeting later than we had assumed. The press conference altered the initial conclusion amongst market participants with certain comments from Governor Ueda suggesting a less dovish interpretation was appropriate. The initial yen selling has since reversed although also due to additional factors beyond the BoJ meeting. We are maintaining our view of a 15bp rate hike at the next meeting on 31st July.
The BoJ today confirmed that it would hold “Bond Market Group” meetings with three different groups – a Commercial banks group; a securities firms group; and a buy-side group. These meetings will help the BoJ formulate a clear plan for reducing its pace of JGB purchases going forward. Governor Ueda stated in the press conference that the objective was to set a reduced purchase plan lasting “one to two years”. Governor Ueda made clear this did not imply completion of reducing JGB holdings but in order to offer market participants a degree of clarity it was decided to set a plan for that period of time. This plan will see JGB holdings on the balance sheet decline from the current level of just above JPY 590trn. Crucially, Governor Ueda stated that the plan would mean a reduction in JGB purchases by a “considerable amount”. Ueda declined to clarify what a “considerable amount” means but this particular description certainly helped begin the turnaround for the yen after the initial selling. There is still a lot in this that is open to interpretation and is quite vague. Any amount of reduction in JGB buying over one year is quite different to a similar amount over two years but Ueda’s communications have certainly helped limit the initial dovish reaction.
The other aspect of today’s press conference that we see as an important take-away was the comments in relation to FX. It would appear to us that the BoJ and Governor Ueda have upped the importance of FX moves on the impact on inflation. Ueda stated today that FX rates likely have a “bigger impact” than in the past.
AFTER TODAY’S CAUTIOUS BOJ MEETING, OIS MARKET PRICING FOR JULY HIKE HAS DROPPED TO 5BPS
Source: Bloomberg, Macrobond & MUFG GMR
BOJ’S BALANCE SHEET 4.5 TIMES LARGER SINCE 2013 EXPANSION BEGAN, NOW EQUATING TO 125% OF GDP
Source: Bloomberg, Macrobond & MUFG GMR
He added that the BoJ was “checking daily the range of FX fluctuations, their sustainability, and the extent to which they will be passed on to domestic prices”. The implications of these comments are that the move of the yen from one meeting to the next could be a key factor in determining whether or not to raise the key policy rate. Governor Ueda has said in previous press conferences that the movement of the yen did not have a “significant impact” on the underlying rate of inflation. Today’s press conference suggests to us that Governor Ueda will not be repeating that view again.
In regard to the general state of inflation relative to BoJ expectations we can certainly conclude that we remain on the course expected by the BoJ and in that regard it adds to the confidence in achieving the virtuous cycle between rising wages and prices. Today, Governor Ueda stated that “if the underlying rate of inflation rises in line with our forecast, we will adjust short-term interest rates”. He added the exact timing can’t be determined and will depend on the data collected at that time. Importantly, he did confirm that a rate hike in July was “certainly possible” and could not be excluded simply because the BoJ will announce the details of the BoJ buying reduction plan. The decision would be dependent on the data at that time. It’s therefore still very plausible that our view of a 15bp rate hike in July will be realised.
This morning, as the press conference was ongoing, our initial take was that the BoJ delay in cutting JGB purchases would be yen negative. However, the yen has since recovered on the possible scale of reduction in JGB buying. The JGB purchase reduction plan though is still unclear (the meaning of “considerable” is subjective) and all-else-equal today’s BoJ meeting has still added to yen downside risks. While some of the rhetoric was more hawkish, we still have another example of BoJ caution through an undershoot of market expectations. We remain in a position of needing external factors to play an important role in strengthening the yen and the prospect of BoJ support for the yen has been pushed back somewhat.
But we would also argue that all-else is not equal and external factors do look to be providing the yen with support. Firstly, the interpretation of the FOMC meeting may be mixed but the reality in the rates market is that the fed funds futures implied yield shows rate cut expectations this week have jumped 30bps in the period to end- 2025. That will limit the upside for USD/JPY. Secondly the dollar is likely to continue performing well versus EUR as the political risk premium grows into the French elections. Our quants section below highlights the rebound in the correlation between JPY and CHF that may be an early sign of the yen’s safe-haven status reviving. The French elections may reinforce this given there has been considerable carry positioning in yen crosses, like EUR/JPY, that may see further position liquidation into the French elections.
USD/JPY VS FED EASING EXPECTED BY END-2025
Source: Macrobond & Bloomberg & MUFG Research
EUR/JPY AT STRETCHED LEVELS, AT GFC HIGHS
Source: Macrobond & Bloomberg & MUFG Research
EUR/GBP: Political risks bring an end to range trading for EUR/GBP
The GBP has continued to be one of the better performing G10 currencies so far this month. While cable has been consolidating between 1.2650 and 1.2800 as the USD has staged a modest rebound, the GBP has continued to strengthen against the EUR resulting in EUR/GBP breaking below important support at the 0.8500-level at the start of this week. The bearish technical developments signal that the pair is likely to continue adjusting lower in the near-term. After breaking below support at the 0.8500-level which had held over the past year, the next important support level is provided by the low from August 2022 at 0.8340 and then the April 2022 low at 0.8250.
The bearish break out for EUR/GBP over the past week has been driven mainly by political developments in Europe. French President Macron’s decision to hold snap parliament elections on 30th June and 7th July has encouraged a weaker EUR as market participants move to price in a higher political risk premium (click here). Heightened fiscal concerns is one area that is attracting more market attention and has already resulted in the yield spread between French and German 10-year government bonds widening sharply to the highest level since in early 2017. Yesterday’s announcement that the left-leaning political parties (the Greens, Socialists, and France Unbowed) in France have sealed a formal alliance have added to those concerns. In contrast, the upcoming general election in the UK which is scheduled to take place on 4th July has had limited impact on GBP performance so far. Market participants remain comfortable with the prospect of the Labour party winning a strong majority in parliament. The release yesterday of the Labour party’s official manifesto (click here) contained no major policy surprises as it outlined relatively modest tax and spend plans. As we highlighted in our UK election preview (click here), a strong Labour majority could even be viewed as supportive for the GBP by welcoming in a period of greater political stability in the UK and opening the door for closer relations with the EU.
The GBP continues to derive support as well from the ongoing improvement in global investor risk sentiment at the start of this year alongside the higher yields on offer in the UK. The recent liquidation of FX carry trades in emerging markets triggered by the election results in South Africa, Mexico and India has had limited spill-over impact for G10 FX carry trades. After the USD, the GBP remains the second most attractive G10 currency carry currency within the G10 after adjusting for currency volatility as well. Please see the table below for G10 FX carry/vol ratios for G10 FX/JPY pairs.
PRICING IN MORE POLITICAL RISK INTO EURO
Source: Bloomberg, Macrobond & MUFG GMR
RANKING CARRY ATTRACTIVENESS FOR G10 FX
Source: Bloomberg, Macrobond & MUFG GMR
The GBP’s recent outperformance would only be challenged if there was a broader deterioration in global investor risk sentiment and/or macro developments in the UK encouraged the BoE to begin cutting rates sooner and more deeply than currently priced into the UK rate market. Market participants are currently pricing in just less than 50:50 probability of a rate cut in August and almost two rate cuts by the end of this year.
The main two main event risks in the week ahead for the GBP that could have a significant impact on BoE rate cut expectations are the release of the latest UK CPI report for May on Wednesday followed by the BoE’s latest policy update on Thursday. Of the two events we expect the release of the UK CPI report to have a bigger impact on GBP performance as it will also have an influence on the BoE’s subsequent policy update. At the BoE’s last policy meeting, they opened the door to begin cutting rates over the summer but those expectations have since been dampened by the upside surprise for services inflation in April which surprisingly held at 5.9% while headline inflation fell back close to the BoE’s target at 2.3% driven by lower energy prices. If services inflation continues to prove persistent in May, it will cast more doubt on the likelihood of the BoE beginning to cut rates in August and encourage a stronger GBP. Whereas if services inflation drops back in May, market expectations for the BoE to begin cutting rates in August would intensify and trigger a reversal of recent GBP gains. In our base scenario we expect the BoE to vote to keep rates on hold next week with the same number of dissenters (MPC members Dhingra and Ramsden) voting for a cut. A much weaker services CPI reading for May would be required to prompt another MPC member to vote for a rate cut next week supported as well by building evidence of the softening labour market.
In these circumstances, we expect the GBP to strengthen further against the EUR ahead of the French parliamentary elections resulting in the pair moving close to support between 0.8250 and 0.8350. The release of the UK CPI report for May would have to be much weaker than expected and/or the BoE send a stronger signal that they are planning to cut rates in August to trigger a reversal of the current trend.
UK SERVICES INFLATION IS PROVING PERSISTENT
Source: Bloomberg, Macrobond & MUFG GMR
SCALING BACK LONG EUR/GBP SPEC POSITIONING
Source: Bloomberg, Macrobond & MUFG GMR
Weekly Calendar
|
Ccy |
Date |
BST |
Indicator/Event |
Period |
Consensus |
Previous |
Mkt Moving |
|
CNY |
06/17/2024 |
03:00 |
Industrial Production YoY |
May |
6.0% |
6.7% |
!! |
|
CNY |
06/17/2024 |
03:00 |
Retail Sales YoY |
May |
3.0% |
2.3% |
!! |
|
CNY |
06/17/2024 |
03:00 |
Fixed Assets Ex Rural YTD YoY |
May |
4.2% |
4.2% |
!! |
|
EUR |
06/17/2024 |
09:00 |
ECB's Lane Speaks |
!!! |
|||
|
EUR |
06/17/2024 |
10:00 |
Labour Costs YoY |
1Q F |
-- |
4.9% |
!! |
|
AUD |
06/18/2024 |
05:30 |
RBA Cash Rate Target |
4.4% |
4.4% |
!!! |
|
|
EUR |
06/18/2024 |
10:00 |
CPI YoY |
May F |
-- |
-- |
!! |
|
USD |
06/18/2024 |
13:30 |
Retail Sales Advance MoM |
May |
0.2% |
0.0% |
!!! |
|
USD |
06/18/2024 |
14:15 |
Industrial Production MoM |
May |
0.4% |
0.0% |
!! |
|
EUR |
06/18/2024 |
17:00 |
Villeroy speaks in Paris |
!! |
|||
|
USD |
06/18/2024 |
18:00 |
Fed Governor Kugler speaks |
!! |
|||
|
NZD |
06/18/2024 |
22:00 |
RBNZ Chief Economist Conway Speaks |
!! |
|||
|
JPY |
06/19/2024 |
00:50 |
Trade Balance |
May |
-¥1335.2b |
-¥462.5b |
!! |
|
GBP |
06/19/2024 |
07:00 |
CPI YoY |
May |
-- |
2.3% |
!!! |
|
EUR |
06/19/2024 |
09:00 |
ECB Current Account SA |
Apr |
-- |
35.8b |
!! |
|
USD |
06/19/2024 |
15:00 |
NAHB Housing Market Index |
Jun |
-- |
45.0 |
!! |
|
CAD |
06/19/2024 |
18:30 |
BoC Releases Summary of Deliberations |
!! |
|||
|
NZD |
06/19/2024 |
23:45 |
GDP SA QoQ |
1Q |
0.1% |
-0.1% |
!! |
|
CHF |
06/20/2024 |
08:30 |
SNB Policy Rate |
-- |
1.50% |
!!! |
|
|
NOK |
06/20/2024 |
09:00 |
Deposit Rates |
-- |
4.50% |
!!! |
|
|
CHF |
06/20/2024 |
09:00 |
SNB's Jordan Speaks |
!!! |
|||
|
GBP |
06/20/2024 |
12:00 |
Bank of England Bank Rate |
5.25% |
5.25% |
!!! |
|
|
USD |
06/20/2024 |
13:30 |
Current Account Balance |
1Q |
-- |
-$194.8b |
!! |
|
USD |
06/20/2024 |
13:30 |
Initial Jobless Claims |
-- |
-- |
!! |
|
|
USD |
06/20/2024 |
13:30 |
Housing Starts |
May |
1375k |
1360k |
!! |
|
JPY |
06/21/2024 |
00:30 |
Natl CPI YoY |
May |
2.9% |
2.5% |
!!! |
|
GBP |
06/21/2024 |
07:00 |
Retail Sales Inc Auto Fuel MoM |
May |
-- |
-2.3% |
!! |
|
GBP |
06/21/2024 |
07:00 |
Public Sector Net Borrowing |
May |
-- |
19.6b |
!! |
|
EUR |
06/21/2024 |
09:00 |
HCOB Eurozone Manufacturing PMI |
Jun P |
-- |
47.3 |
!!! |
|
EUR |
06/21/2024 |
09:00 |
HCOB Eurozone Services PMI |
Jun P |
-- |
53.2 |
!!! |
|
GBP |
06/21/2024 |
09:30 |
S&P Global UK Manufacturing PMI |
Jun P |
-- |
51.2 |
!!! |
|
GBP |
06/21/2024 |
09:30 |
S&P Global UK Services PMI |
Jun P |
-- |
52.9 |
!!! |
|
CAD |
06/21/2024 |
13:30 |
Retail Sales MoM |
Apr |
0.7% |
-0.2% |
!! |
|
USD |
06/21/2024 |
14:45 |
S&P Global US Composite PMI |
Jun P |
-- |
54.5 |
!! |
Source: Bloomberg, Macrobond & MUFG GMR
Key Events:
- There is a heavy schedule of G10 central bank policy updates in the week ahead. The RBA holds their latest policy meeting on Tuesday followed by the SNB, Norges Bank and BoE who all hold their latest policy meetings on Thursday. We expect all four central banks to leave their policy rates unchanged although it is a closer call for the SNB who are weighing up whether to deliver a second back to back 25bps rate cut. The Swiss rate market is currently pricing in around 19bps of cuts for next week’s SNB meeting. We dropped our call for another cut after SNB President Jordan expressed concern over upside inflation risks from a weaker CHF. However, the CHF has since strengthened so far this month which could tip the balance in favour of another cut.
- Recent inflation and wage developments in the UK have been disappointing and argue against the BoE sending a stronger signal next week that they are moving closer to cutting rates. The latest UK CPI report for May will be released ahead (Wednesday) of the MPC meeting ad could have material impact on the policy signal delivered. We are currently expecting the same voting split as at the last MPC meeting in May when 7 MPC members voted in favour of leaving rate son hold and two MPC member (Swati Dhingra and Dave Ramsden) voted for a rate cut. A weaker May CPI report would increase the likelihood of the BoE delivering a more dovish policy signal next week.