JPY rebound extends after Japan election fails to trigger further weakness

JPY: Scaling back yen shorts ahead of NFP report

The yen has continued to rebound overnight following the lower house election in Japan at the weekend. USD/JPY initially rose to a high of 157.76 after it was confirmed that the LDP had won a super majority on their own, but the pair has since fallen sharply and hit a low overnight 152.80 moving back closer to the lows from in late January at 152.10. The yen’s failure to weaken further even after Prime Minister Takaichi strengthened her grip on power in Japan has likely encouraged speculators to further scale back short yen positions in the near-term. The yen has rebounded even as Prime Minister Takaichi has announced her intention to promptly start discussions on reducing the consumption tax on food at a bipartisan national council and to present an interim plan before the summer. She has pledged to freeze the sales tax on food for a two-year period. It is viewed as a “bridging measure limited to two years” until the “implementation of “tax credit with cash payments”, which would combine direct cash payments and income tax cuts. She did acknowledge though that there issues to be worked out, such as the burden on businesses, the timing of the tax cut, securing alternative financial revenues, and the possible impact on financial markets. However, she still thinks it can be implemented “as early as possible”. She did emphasize though that the government will “not use debt issuance” to fund the freeze, and characterised the policy as central to her “responsible, proactive fiscal policy”. The rebound for the yen indicates that market participants may have already priced in a sufficient policy risk premium into the yen. USD/JPY was trading between 145.00 and 150.00 prior to the change in LDP leadership in the autumn before rising back closer to the 160.00-level at the start of this year. The sharp yen sell-off during this period happened even as the BoJ hiked rates while the Fed cut rates further.

Fed rate cut expectations have picked back up this week encouraging a weaker US dollar, and reinforcing the move lower in USD/JPY. The US rate market has moved to price back in a higher probability of the Fed delivering three rate cuts this year. There are currently around 61bps of cuts priced in by year end compared to around 53bps at the end of last month. It has helped to lower the 2-year US Treasury yield back closer to the lows from October at just below 3.4%. The dovish repricing was further encouraged yesterday by the release of the much weaker than expected US retail sales report for December and softer Employment Cost Index for Q4. The softer December retail sales print and downward revisions to growth from prior month indicates that consumption growth is likely to slow to around 2.5% in Q4 down from 3.5% in Q3. For the second half of last year consumption growth was still solid but it has put a dampener on recent optimism for even stronger US growth. The softer Employment Cost data which showed total compensation increasing by 0.7%Q/Q in Q4. Historically the Fed has judged that wage growth of around 3% is consistent with meeting their inflation target, but that bar may be raised if higher productivity is sustained. Slowing wage growth and higher productivity growth leaves the door open for further rates cuts this year supporting our forecast for a weaker US dollar (click here).  Whether US dollar’s sell-off extends further this week will depend on the release of the delayed nonfarm payrolls report for January later today. Market participants are fearful of another soft month of employment growth after comments earlier this week from Kevin Hassett (click here) and the recent soft ADP survey and JOLTs report.  

ROOM FOR USD/JPY TO FALL FURTHER IF RISK PREMIUM SCALED BACK

Source: Bloomberg, Macrobond & MUFG GMR

AUD: Hawkish RBA guidance is reinforcing upward momentum

The Australian dollar has continued to outperform at the start of this year extending its advance to almost 6.5% against the US dollar. The outsized gains for the Australian dollar have been encouraged by the RBA’s decision to start hiking rates ahead of other G10 central banks with the exception of the BoJ. Hawkish comments from RBA Deputy Governor Andrew Hauser overnight have indicated that this month’s rate hike may not be a one off. He warned that inflation is still “too high” and remains a significant challenge to the RBA board, which can’t allow it to go on much longer. He believes that some of the recent pick-up in inflation “reflects growing underlying pressure about pick-up in demand against supply constraints in the economy”, and “if that’s true. The risk is higher inflation may persist, and we can’t let that happen”. He added that “we have to respect the speed limit of the economy because if the RBA tries to run it “hotter than it can run, inflation will pick up, and that’s the number one issue that harms productivity growth”. The hawkish comments have reinforced market expectations that the RBA will hike rates again as soon as May.

We continue to recommend a long AUD/GBP trade idea (click here) which has been benefitting from widening expectations for policy divergence between the RBA and BoE who is expected to lower rates further as soon as next month. The Australian dollar has continued to strengthen this month even as commodity prices have corrected lower after strong gains at the start of this year. MSCI’s ACWI global equity index has risen to fresh record highs highlighting that investor risk sentiment remains supportive for high beta currencies such as the Aussie.            

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com