USD/JPY moves back to within touching distance of the 150.00-level

USD: A stronger USD heading into US election

The US dollar has continued to trade on a stronger footing overnight helping to lift USD/JPY back to within touching distance of the 150.00-level as it moves further above the low of 139.58 set on 16^th September. The rebound for USD/JPY continues to be supported by the ongoing pick-up in US yields both at the short and long end of the curve. The 2-year US Treasury yield closed back above 4.00% yesterday for the first time since mid-August. The move higher in short-term US yields has been supported by the release of the minutes from the September FOMC meeting at which the Fed started to ease monetary policy by delivering a larger 50bps rate cut. The minutes have reinforced the perception amongst market participants that the Fed will be more cautious over the scale of further rate cuts in line with their plans to deliver smaller 25bps cuts at the upcoming policy meetings. The minutes revealed that “some” FOMC participants preferred to deliver a 25bps rate cut at the September FOMC meeting and a “few others” could have backed a smaller move. It indicates that there was more opposition to the Fed’s decision to deliver a larger 50bps rate cut in September than initially indicated when Fed Governor Bowman was the only participant to cast a dissenting vote. A few participants also added that a 25bps rate cut could signal a more predictable path of policy normalization. The comments reinforce the impression that the larger 50bps rate cut to begin the easing cycle was more of a one off as the Fed attempted to play catch up after deciding against cutting rates at the previous meeting in July, and they were wary of falling behind the curve. Recent comments from Fed officials have indicated that they are more comfortable with their current policy outlook.

For the Fed to deliver further larger 50bps rate cuts, it will require evidence of a sharper slowdown in the US labour market which was not evident in the latest nonfarm payrolls report. Market attention will now turn today to the release of the latest US CPI report for September. After picking up more strongly than expected in August,  market participants will be watching closely to see if the core CPI reading slows in September. The US dollar initially strengthened after the stronger CPI readings for August but there was little follow after stronger inflation was mainly in components that carry less weight in the Fed’s preferred inflation measure the PCE deflator. As we saw at the end of last month the core PCE deflator remained weak in August. We are still confident that slowing inflation will encourage the Fed to keep cutting rates but it is unlikely that today’s report will be sufficient to prompt the US rate market to price back in more aggressive easing again from the Fed in the near-term.   

Higher yields at the long end of the US curve have also been supported recently by the pick-up in the price of oil which has lifted market-based measures of inflation expectations. The price of Brent briefly rose back above USD80/barrel earlier this week up from a low of USD69.91 at the start of October. It has since dropped back towards USD77/barrel in recent days in response to reports that Israel is planning to hit military targets in Iran rather than their nuclear facilities and/or oil production sites. The price action highlights that market participants remain nervous over the risk of a further escalation in Middle East tensions and are still waiting to assess Israel’s retaliatory response to last week’s missile attacks by Iran. Even though the price of oil has dropped back in recent days, the yield on the 10-year Treasury has continued to move higher. The price action suggests other factors are at play and could be an indication that market participants are pricing in more of a risk premium to reflect the rising probability of Donald Trump becoming the next president. According to Polymarket, the probability of Trump winning has risen up to 53.5% this week. A development that would be supportive for the US dollar as well posing upside risks for US yields.       

PRICING IN MORE OF A TRUMP RISK PREMIUM INTO US YIELDS & USD

Source: Bloomberg, Macrobond & MUFG GMR

EUR: ECB policy & France fiscal risks in focus

The hawkish repricing of Fed ate cut expectations has weighed on EUR/USD and helped to drag it back below support at the 1.1000-level this week. It stands in contrast to market expectations for the ECB to speed up the pace of rate cuts at next week’s policy meeting. Bank of France Governor Francois Villeroy de Galhau stated yesterday that “a drop is very likely, and that it will not be the last”. At the same time, he talked down the possibility of the ECB delivering larger rate cuts than 25bps. He stated that “we have gotten into the habit of acting gradually, that is to say resolutely, but without taking big steps”. The comments support euro-zone rate market expectations for the ECB to deliver a back-to-back 25bps rate cut next week and to keep lowering rates in 25bps increments at least through into the middle of next year that would lower the policy rate closer to neutral territory at around 2.00%.

Market participants are also waiting for further budget details from the new French government. Prime Minister Michel Barnier government survived its first no-confidence motion in the National Assembly a couple of days ago. The left-win New Popular Front coalition promoted the motion of no-confidence but it received only 197 votes in favour which was well below the 289 votes required to pass. Prime Minister Barnier’s government survived primarily due to the abstention of the right-wing National Rally party. The developments suggest that the National Rally party are unlikely to vote to bring down the government while it is attempting to pass a budget for next year. Prime Minister Barnier has already outlined that they plan to bring the budget deficit down from around 6% of GDP this year to closer to 5% of GDP next year. That would require a reduction of around 1 percentage point of GDP equating to EUR30 billion. He also outlined his plan to delay bring the budget deficit back below 3% of GDP by two years out until to 2029. France must submit a fiscal plan to the European Commission by 31^st October. The plan is expected to meet EU fiscal rules by bringing the deficit below 3% within the adjustment period while being consistent with the minimum adjustment of 0.5 percentage points per year. One of the main risks to the government’s plans for fiscal consolidation next year would be weaker than expected growth in France with growth of around 1% expected next year. Higher taxes could act as damper on the growth outlook. So far the fiscal developments in France have had limited negative impact on euro performance. The spread between 10-year French and German government bonds would need to significantly widen out beyond recent highs at around 80bps to weigh more on the euro. One potential banana skin at the end of this week is the Fitch’s review of France’s credit rating tomorrow. We are expecting the credit rating to be placed on negative watch but a downgrade can’t be ruled out.      

FISCAL RISK IN FRANCE REMAINS ELEVATED

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	09:30	BOE Credit Conditions Survey	--	--	--	!!
EC	12:30	ECB Publishes Account of Monetary Policy Meeting	--	--	--	!!
US	13:30	Core CPI (MoM)	Sep	0.2%	0.3%	!!!
US	13:30	CPI (MoM)	Sep	0.1%	0.2%	!!!
US	13:30	Initial Jobless Claims	--	231K	225K	!!!
US	15:30	FOMC Member Barkin Speaks	--	--	--	!
US	16:00	FOMC Member Williams Speaks	--	--	--	!!
GE	18:00	German Buba President Nagel Speaks	--	--	--	!!

Source: Bloomberg