USD JPY - FUNDAMENTAL DRIVERS
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
With headline inflation at 8.5%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their July meeting, and continuing with QT. Despite the increased fears of a possible recession, the Fed minutes confirmed that the Fed is far away from stopping rate hikes and squashed hopes of a Jackson Hole dovish pivot. The Fed did announce a more data-dependent stance at their July policy meeting, explaining that the pace of hikes is likely to slow as rates get more restrictive and as more data becomes available. STIR markets have repriced lower to reflect this. With the Fed signalling data-dependence, the incoming growth, inflation and jobs data will be a key driver for USD price action where we expect a cyclical reaction to incoming data (good data being good and bad data being bad for the USD and US10Y). But the USD safe haven status is important to keep in mind. Even though price pulled back after the Fed’s July meeting, the still uncomfortably high inflation and Fed minutes saw a Jackson Hole Symposium Pivot pushed back and this has seen similar support for the USD like we saw from the start of the year where bonds pushed lower, and the USD gained on safe haven demand.
POSSIBLE BULLISH SURPRISES
With the Fed’s data-dependent messaging pushing rates lower, any incoming data that sparks further aggressive hike expectations, or comments from the FOMC that signals even more aggressive policy could trigger bullish reactions. As the cyclical outlook continues to weaken, the USD’s safe haven status still matters. Any incoming data that exacerbates fears of recession and triggers a big flush in risk assets and triggers a rush to safety should be positive for the USD. Any further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields (commodity prices, actual inflation and inflation expectations, more aggressive tightening rhetoric from Fed) could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
With the Fed signalling a data dependent policy stance, we expect a cyclical reaction from the USD with incoming US data. Thus, extremely bad growth, inflation or jobs data is expected to trigger short-term bearish reactions in the USD. The USD is trading close to cycle highs while aggregate CFTC positioning is close to levels that previously acted as local tops. Stretched positioning could make the USD vulnerable to shortterm corrections, especially with bad US data points. With a lot still priced for the Fed, it won’t take much to disappoint on the dovish side. Any FOMC comments that suggests more concern about growth than inflation could trigger bearish reactions in the USD, but with inflation so high any major dovish pivots seem a while away.
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays hawkish and cyclical concerns put pressure on risk assets. However, the data dependence stance from the Fed means we want to be mindful that lots has been priced for the USD, and as growth deteriorates, it could impact the USD negatively, even though current inflation suggests any dovish pivot seems a while away. Also, as the safe haven of choice, any further recession focused downside in risk assets or continued downside in US bonds due to sticky inflation and an aggressive Fed could continue to prove supportive for the USD. In the short-term though, with positioning in mind, and a dual-growth narrative (one being good for the USD and the other being bad for the USD) we prefer short-term catalysts that offer short-term sentiment-based trades.
JPY
FUNDAMENTAL OUTLOOK: BEARISH
BASELINE
In recent weeks, yield differentials have been the biggest negative driver for the JPY with the BoJ keeping 10-year JGB yields capped at 0.25% with yield curve control while other central banks are hiking rates aggressively. Thus, the BoJ’s reluctance to shift on policy even with inflation starting to push higher remains a negative driver for the JPY. Even though the JPY is considered a safe haven, inflows has been limited in the current bear market compared to other cycles. The reason is Japan’s current account surplus (a main reason for safe haven appeal) has deteriorated due to the rise in commodity prices. Japan imports the bulk of their commodities , so very high energy prices has added to downside. The BoJ and MoF’s reluctance to intervene to stop the rapid depreciation in the JPY in recent weeks has been noticeable. As long as they just voice their dislike but fail to act, the market will keep testing them. Having said that, US10Y and commodities have been reacting more and more negative to the current negative cyclical growth outlook, and as a result has seen big players trim their massive JPY shorts. But this past week’s push higher in yields was a friendly reminder that inflation and yield differentials remain a major downside risk for the JPY, despite the negative cyclical outlook.
POSSIBLE BULLISH SURPRISES
Catalyst that triggers speculation that the BoJ could drop YCC or hike rates or both (big upside surprises in inflation ) could trigger upside in JPY, which means inflation data will be important to keep on the radar. Catalysts that trigger meaningful corrections in US10Y (less hawkish Fed, faster deceleration in US inflation , faster deceleration in US growth) or meaningful bouts of risk off sentiment could trigger bullish reactions from the JPY. Any catalyst that triggers meaningful downside in key commodities like Oil (deteriorating demand outlook, ease in supply shortage) could trigger bullish JPY reactions. Any intervention from the BoJ or MoF to stop JPY depreciation (buying the JPY or giving firm and clear lines in the sand for USDJPY ) could offer decent reprieve for the JPY.
POSSIBLE BEARISH SURPRISES
With yield differentials playing such a huge role for the JPY, any catalysts that push US10Y higher (more aggressive Fed, further acceleration in US inflation , better-than-expected US growth data) could trigger further bearish price action for the JPY. Any catalyst that creates further upside in oil prices (further supply concerns, geopolitical tensions) poses downside risks for Japan’s current account surplus and could trigger further bearish reactions in the JPY. Further reluctance from the BoJ and MoF to address the concerning depreciation in the JPY, and further reluctance from the BoJ to pivot away from very dovish policy is a continued negative driver for the JPY to keep on the radar. If the BoJ pushes back against calls for a policy shift despite upside surprise in CPI could trigger further JPY downside.
BIGGER PICTURE
The fundamental outlook remains bearish for the JPY, especially after the BoJ once again stuck to the same overly dovish script at their July meeting. As long as US10Y remain elevated and the BoJ stays stubbornly dovish and no push back is made against the JPY weakness from the BoJ or MoF, the bias remains lower. But take note of positioning which means we don’t want to chase the JPY lower and bullish reactions can see outsized upside on big drops in US10Y & commodities . It also means watching incoming CPI data closely as any huge upside surprises could trigger speculation of a possible policy shift.
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
With headline inflation at 8.5%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their July meeting, and continuing with QT. Despite the increased fears of a possible recession, the Fed minutes confirmed that the Fed is far away from stopping rate hikes and squashed hopes of a Jackson Hole dovish pivot. The Fed did announce a more data-dependent stance at their July policy meeting, explaining that the pace of hikes is likely to slow as rates get more restrictive and as more data becomes available. STIR markets have repriced lower to reflect this. With the Fed signalling data-dependence, the incoming growth, inflation and jobs data will be a key driver for USD price action where we expect a cyclical reaction to incoming data (good data being good and bad data being bad for the USD and US10Y). But the USD safe haven status is important to keep in mind. Even though price pulled back after the Fed’s July meeting, the still uncomfortably high inflation and Fed minutes saw a Jackson Hole Symposium Pivot pushed back and this has seen similar support for the USD like we saw from the start of the year where bonds pushed lower, and the USD gained on safe haven demand.
POSSIBLE BULLISH SURPRISES
With the Fed’s data-dependent messaging pushing rates lower, any incoming data that sparks further aggressive hike expectations, or comments from the FOMC that signals even more aggressive policy could trigger bullish reactions. As the cyclical outlook continues to weaken, the USD’s safe haven status still matters. Any incoming data that exacerbates fears of recession and triggers a big flush in risk assets and triggers a rush to safety should be positive for the USD. Any further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields (commodity prices, actual inflation and inflation expectations, more aggressive tightening rhetoric from Fed) could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
With the Fed signalling a data dependent policy stance, we expect a cyclical reaction from the USD with incoming US data. Thus, extremely bad growth, inflation or jobs data is expected to trigger short-term bearish reactions in the USD. The USD is trading close to cycle highs while aggregate CFTC positioning is close to levels that previously acted as local tops. Stretched positioning could make the USD vulnerable to shortterm corrections, especially with bad US data points. With a lot still priced for the Fed, it won’t take much to disappoint on the dovish side. Any FOMC comments that suggests more concern about growth than inflation could trigger bearish reactions in the USD, but with inflation so high any major dovish pivots seem a while away.
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays hawkish and cyclical concerns put pressure on risk assets. However, the data dependence stance from the Fed means we want to be mindful that lots has been priced for the USD, and as growth deteriorates, it could impact the USD negatively, even though current inflation suggests any dovish pivot seems a while away. Also, as the safe haven of choice, any further recession focused downside in risk assets or continued downside in US bonds due to sticky inflation and an aggressive Fed could continue to prove supportive for the USD. In the short-term though, with positioning in mind, and a dual-growth narrative (one being good for the USD and the other being bad for the USD) we prefer short-term catalysts that offer short-term sentiment-based trades.
JPY
FUNDAMENTAL OUTLOOK: BEARISH
BASELINE
In recent weeks, yield differentials have been the biggest negative driver for the JPY with the BoJ keeping 10-year JGB yields capped at 0.25% with yield curve control while other central banks are hiking rates aggressively. Thus, the BoJ’s reluctance to shift on policy even with inflation starting to push higher remains a negative driver for the JPY. Even though the JPY is considered a safe haven, inflows has been limited in the current bear market compared to other cycles. The reason is Japan’s current account surplus (a main reason for safe haven appeal) has deteriorated due to the rise in commodity prices. Japan imports the bulk of their commodities , so very high energy prices has added to downside. The BoJ and MoF’s reluctance to intervene to stop the rapid depreciation in the JPY in recent weeks has been noticeable. As long as they just voice their dislike but fail to act, the market will keep testing them. Having said that, US10Y and commodities have been reacting more and more negative to the current negative cyclical growth outlook, and as a result has seen big players trim their massive JPY shorts. But this past week’s push higher in yields was a friendly reminder that inflation and yield differentials remain a major downside risk for the JPY, despite the negative cyclical outlook.
POSSIBLE BULLISH SURPRISES
Catalyst that triggers speculation that the BoJ could drop YCC or hike rates or both (big upside surprises in inflation ) could trigger upside in JPY, which means inflation data will be important to keep on the radar. Catalysts that trigger meaningful corrections in US10Y (less hawkish Fed, faster deceleration in US inflation , faster deceleration in US growth) or meaningful bouts of risk off sentiment could trigger bullish reactions from the JPY. Any catalyst that triggers meaningful downside in key commodities like Oil (deteriorating demand outlook, ease in supply shortage) could trigger bullish JPY reactions. Any intervention from the BoJ or MoF to stop JPY depreciation (buying the JPY or giving firm and clear lines in the sand for USDJPY ) could offer decent reprieve for the JPY.
POSSIBLE BEARISH SURPRISES
With yield differentials playing such a huge role for the JPY, any catalysts that push US10Y higher (more aggressive Fed, further acceleration in US inflation , better-than-expected US growth data) could trigger further bearish price action for the JPY. Any catalyst that creates further upside in oil prices (further supply concerns, geopolitical tensions) poses downside risks for Japan’s current account surplus and could trigger further bearish reactions in the JPY. Further reluctance from the BoJ and MoF to address the concerning depreciation in the JPY, and further reluctance from the BoJ to pivot away from very dovish policy is a continued negative driver for the JPY to keep on the radar. If the BoJ pushes back against calls for a policy shift despite upside surprise in CPI could trigger further JPY downside.
BIGGER PICTURE
The fundamental outlook remains bearish for the JPY, especially after the BoJ once again stuck to the same overly dovish script at their July meeting. As long as US10Y remain elevated and the BoJ stays stubbornly dovish and no push back is made against the JPY weakness from the BoJ or MoF, the bias remains lower. But take note of positioning which means we don’t want to chase the JPY lower and bullish reactions can see outsized upside on big drops in US10Y & commodities . It also means watching incoming CPI data closely as any huge upside surprises could trigger speculation of a possible policy shift.
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