GBP JPY - FUNDAMENTAL DRIVERSGBP
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The overall bleak economic outlook for the UK, with exceptionally high Inflation and rapidly falling growth have been the biggest negative driver for Sterling. At their August meeting, the BoE confirmed this bleak outlook by forecasting the UK economy to fall into recession by 4Q22 and expects the recession to last for five quarters. Even though the bank followed through with a 50bsp hike, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, the bank is stuck between a rock and a hard place as they are forced to keep hiking rates to try and fight inflation but by doing so, they risk further damaging economic growth as a result. Even though Sterling is still fairly close to recent lows (at the index level), the recent bounce was enough to short into, and we saw sizeable downside following the BoE decision. It seems unlikely that the post-BoE price action reflects a market that has already priced in a 5-quarter recession, so we expect sentiment to remain bearish on Sterling for now.
POSSIBLE BULLISH SURPRISES
Stagflation fears are very high for the UK, with probabilities of recession growing by the week. With a recession now the base assumption, any incoming news that surprises meaningfully higher could trigger some relief. The UK is facing a huge cost-of-living squeeze, which means lower-than-expected inflation could counterintuitively be a positive driver (as lower CPI means less stagflation risk). The economy needs help right now, which means any help from the fiscal side will be a positive. Any major fiscal support measures to help consumers (subsidies for energy or tax cuts) could trigger bullish reactions for the Pound. Any overly hawkish fiscal promises from PM candidates which eases recession fears could be a positive trigger for Sterling. Any overly hawkish comments signalling more aggressive policy than what markets are currently pricing in could trigger bullish reactions.
POSSIBLE BEARISH SURPRISES
Odds that the BoE has limited hikes left has been a negative driver, but so too is risks that inflation forces them to hike even more and further damage GDP. Further stagflation risks from higher gas prices or CPI could trigger bearish reactions. Politicsremain a focus, where any attempts by a new PM in the weeks or months ahead to call for a snap election should cause unnecessary uncertainty and could trigger GBP downside. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus again. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside. Any overly dovish fiscal promises from PM candidates that increase recession fears could be a negative trigger for Sterling Any overly dovish comments signalling less aggressive policy than what markets are currently pricing in could trigger bearish GBP reactions.
BIGGER PICTURE
The fundamental outlook for the GBP remains bleak, especially after the BoE’s recent forecasts of a 5-quarter recession in the UK. Furthermore, given the risks to growth, there is growing speculation that the BoE might not be too far away from pausing. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure should be positive. The post-BoE price action was big, but not big enough for a market that has priced in a deep recession, which means we would expect sentiment to remain soft on Sterling after the most recent BoE meeting, but incoming data this week could trigger short-term sentiment reactions as always.
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. If this continues it should continue to support the currency on any negative data surprises from the US, especially given the size of current JPY short positions.
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 biasremains 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.
