US dollar stabilises close to highs – Japan & France uncertainties persist

USD: Fed minutes and French optimism halts dollar buying

The US dollar buying has stalled with some modest reversal of recent gains as investors see prospects of a deal being reached to agree a 2026 budget in France. In what looks like a climbdown by President Macron, the suspension of pension reform has been put on the table as a way to reach a compromise. This would help break the gridlock although an estimated EUR 3bn-3.5bn of savings would have to be found over the coming two years to cover the cost. The French government has already estimated that the cost of suspending the pension reforms would rise to EUR 13bn by 2035. A new prime minister is expected to be named by tomorrow in order to proceed with negotiations. The fact that progress looks to have been made has helped lift the euro and narrow the OAT/Bund spread 3bps to 83bps. Still, risks remain high and political uncertainty will persist curtailing euro buying. FX moves have been very modest.

The slight rebound in EUR/USD also coincided with the release of the FOMC minutes although the impact in the rates market was marginal. US yields softened very modestly and overall there was nothing too surprising in the minutes with the focus at the September FOMC meeting more on concerns over the weakening labour market than on the continued upside risks from inflation due to President Trump’s tariff policies. The minutes revealed that “a few” FOMC members could have supported no rate cut in September with the majority of members believing there was upside risks to the inflation outlook. Still, despite these views, “most” members stated it was likely appropriate to ease policy further this year. The Fed staff also noted upside inflation risks and the view that inflation could prove persistent. Assuming the flow of economic data continues as we have seen, a rate cut on 29^th October seems most likely and that prospect remains close to fully priced.

That said, the minutes do also highlight the fact that perhaps just one bad inflation print would be enough to see the FOMC change tack and quickly decide to hold off cutting. But the government shutdown means we may not get any top-tier jobs or inflation data before that meeting and given the guidance and the pricing a rate cut would then most likely still be delivered. The cyclical factors will ultimately outweigh the political uncertainty factors with the potential for those uncertainties to recede.

LEVERAGED JPY SHORTS AT ABOUT 50% OF LEVEL SEEN IN 2024

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Time to fade USD/JPY? New Komeito clarity needed first

The USD/JPY rate is now over five big figures higher from Friday’s close and the move has extended beyond our initial assumption of there being a potential for a 2-3 big figure increase on a scenario of Sanae Takaichi winning the LDP leadership election at the weekend. The move in the yen appears now to be less about fiscal concerns and easing expectations of BoJ rate hikes and more about positioning and momentum trading amongst shorter-term market participants. Since the initial drop in expectations of rate hikes by the BoJ over coming meetings, we have seen a slight pick-up in rate hike expectations since and a rate hike is now priced at about 80% for the January 2026 meeting. Expectations for a hike in October and December have been broadly stable since the initial drop on Monday. Yesterday there was also a positive 30-year JGB auction that saw a bid-to-cover that was slightly stronger than the average over the last 12mths and a tail that was narrower. The 30-year JGB yield yesterday reversed the entire increase on Monday in response to Takaichi’s surprise victory. So the perception of Takaichi being a reflationist pushing for more fiscal spending and forcing the BoJ to the sidelines hasn’t really been reflected in the OIS and JGB markets since the initial reaction on Monday. JGBs could have been helped also by the decision of Takaichi to appoint Shunichi Suzuki as LDP Secretary General and Taro Aso as Vice President. Both are deemed as cautious on additional fiscal spending from their previous roles of finance minister (Aso is a former PM as well). Aso was FM during Abenomics but was seen as a moderating force against more aggressive fiscal stimulus and the far more powerful stimulus under Abenomics was monetary easing.

Takaichi’s opposition to BoJ rate hikes is probably a more valid factor in yen weakness given last year she described hiking rates as “foolish”. But we suspect BoJ rate hike expectations to become much more closely aligned with moves in FX going forward. The 5-big figure move if extended to say levels around 155 or above would likely dilute Takaichi’s opposition to a rate hike. Vocal complaints from Washington could have a big influence ahead of President Trump’s scheduled trip to Japan from 27^th to 29^th October. If the yen is weaker still by then US Treasury Secretary Scott Bessentt may well have made vocal complaints and if the semi-annual currency report has been released (scheduled for October but may not be released due to the shutdown) it will likely be much more critical of Japan’s monetary policy. So these factors will likely see BoJ rate hike expectations revived that will help to counter the appetite to sell yen at weaker levels.

Some of the extended yen selling likely reflects risk of worsening political instability. Coalition negotiations with New Komeito has forced Takaichi to delay reconvening the Diet from 15th to 20th October. New Komeito and the LDP will reconvene tomorrow but this has become the key source of near-term uncertainty. New Komeito are unhappy with LDP actions taken to tighten party funding rules and by Takaichi’s stance on visiting the Yasukuni Shrine. New Komeito will hold a national conference later today and a decision not to join a coalition would be a surprise and greatly increase political instability risks. That would likely propel the yen weaker still.

So while we would argue the extent of yen selling is starting to look stretched, the New Komeito uncertainty means there remains near-term downside risks. If the coalition is maintained then a yen rebound looks more plausible. The weakening US economy and the likelihood of further Fed rate cuts will see the risk-reward in USD/JPY shift. A deal with New Komeito is key but assuming that happens, the reasons for continued yen selling at these levels is increasingly less compelling.

1M USD/JPY RISK-REVERSAL CLOSE TO POSITIVE FOR 1ST TIME SINCE 2022 – OPTIONS SHIFT TO UPSIDE LOOKS OVERDONE

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com