JPY continues to rebound as carry trades unwind ahead of BoJ policy meeting

JPY: Yen-funded carry trade unwind continues ahead of BoJ policy update  

The yen has continued to strengthen overnight resulting in USD/JPY falling to a fresh low of 154.37. It is the lowest level since the middle of May. The pair has now fallen by -4.7% since the high from the start of this month at 161.95. The scale of the correction lower is moving closer to the temporary adjustment lower recorded in late April/early May just after Japan intervened to support the yen when USD/JPY fell by -5.2%. There have been no new fundamental triggers for the continued yen rebound overnight which is likely driven by a further scaling back of yen-funded carry trades. Since USD/JPY peaked on 11^th July, the worst performing yen crosses have been CLP/JPY (-6.1%), BRL/JPY (-5.2%), MXN/JPY (-4.9%) and ZAR/JPY (-4.8%). The high yielding emerging market currencies have been hit the hardest as carry trades have been unwound. As we highlighted in yesterday’s FX Daily Snapshot report (click here), the yen’s recent upward momentum has been reinforced by further comments from leading Japanese politicians signalling concern over the slow pace of the BoJ’s policy normalization. The comments have heightened speculation that the BoJ will tighten policy further at next week’s policy meeting on 31sy July. The yields on the 2-year and 10-year JGB have risen back closer to the year to date highs set at just above 0.4% and 1.1% respectively.

We continue to believe that there is room for yields in Japan to keep adjusting higher as market participants are under-pricing the BoJ rate hike cycle and we expect the BoJ to announce plans to significantly slowdown JGB purchases in the coming years. While higher Japanese yields will offer more support for the yen, it remains even more important for the Fed and other major central banks to lower interest rates back towards more neutral levels in response to slowing inflation in order to encourage a more sustained rebound for the yen. The release of the much weaker US CPI report for June was important as it provided the most compelling evidence yet that inflation continues to slow and has given market participants more confidence that the Fed will be more active in cutting rates in the year ahead. Nevertheless, the yen could quickly give back recent strong gains if the BoJ again disappoints market expectations for policy tightening at next week’s policy meeting. Please see our latest FX Weekly report (click here) for more detailed thoughts on recent yen developments.              

UNWINDING OF JPY-FUNDED CARRY TRADES

Source: Bloomberg, Macrobond & MUFG GMR

CAD: Back to back BoC rate cut expectations have been weighing on CAD

The Canadian dollar has weakened ahead of today’s BoC policy meeting. It has resulted in USD/CAD rising back closer to the year to date high from 16^th April at 1.3846 after attempting and failing to break below support from the 200-day moving average at just below the 1.3600 earlier this month. The external backdrop has been unfavourable for the Canadian dollar in recent weeks as investors have turned more risk-averse and the price of oil has dropped back towards year to date lows reflecting in part renewed concerns over the global growth after China’s economy lost growth momentum in Q2. The releases of the latest PMI surveys from Europe (euro-zone & UK) for July will also be watched closely to see if the pullback in business confidence at the end of Q2 has continued at the start of Q3.

At the same time, the Canadian rate market remains confident that the BoC will deliver back to back rate cuts today. There are currently around 22bps of cuts priced in for today’s BoC policy meeting and around 64bps of cuts by year end indicating that the BoC is expected to continue lowering rates through the rest of this year. At the last policy meeting Governor Macklem indicated that the BoC is comfortable to keep cutting rates ahead of the Fed and policy divergence is not yet at the point where it could become a problem. We expect the BoC to take the opportunity to lower rates further today given it is already well priced in. Even though inflation has picked up in recent months, it has been moving towards the BoC’s target this year and the policy rate rate remains at restrictive levels. The recent jump in the unemployment rate to 6.4% in June should provide reassurance as well that domestic inflation pressures are likely to ease further. It would be a much bigger surprise if the BoC disappointed market expectations today and left rates on hold which would trigger a bigger CAD reaction. There has been a significant pick-up in short CAD positions held by Leveraged Funds in recent months built on the back of monetary policy divergence expectations.             

USD/CAD VS. SHORT-TERM VALUATION MODEL ESTIMATE  

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	Manufacturing PMI	Jul	46.0	45.8	!!
EC	09:00	Services PMI	Jul	52.9	52.8	!!
UK	09:30	Manufacturing PMI	--	51.1	50.9	!!!
UK	09:30	Services PMI	--	52.5	52.1	!!!
EC	13:00	ECB's Lane Speaks	--	--	--	!!
US	13:30	Building Permits	--	1.446M	1.399M	!!
US	14:45	S&P Global Composite PMI	Jul	--	54.8	!!
CA	14:45	BoC Interest Rate Decision	--	4.50%	4.75%	!!!
US	15:00	New Home Sales	Jun	639K	619K	!!!
CA	15:30	BOC Press Conference	--	--	--	!!

Source: Bloomberg