USD & JPY underperform in response to central bank & political risks

USD: Trump intensifies attack on Fed’s independence after NFP report

The US dollar has corrected lower at the start of the week giving back all of the gains recorded following the release of the latest nonfarm payrolls report on Friday. After hitting a high of 99.264 on Friday, the dollar index has fallen back to a low overnight of 98.772. The US dollar sell-off has been triggered by the announcement from Fed Chair Powell that the Trump Department of Justice has served the Fed with subpoenas threatening criminal indictment over his testimony relating to building cost overruns. In a recorded statement, Fed Chair Powell stated that the testimony and renovation costs are “pretexts”, and he views the threat of criminal indictment as an attack on the Fed’s independence. He stated specifically that “the threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the president”. He believes “this is about whether the Fed will be able to continue to set interest rates based on evidence and economic conditions – or whether  instead monetary policy will be directed by political pressure or intimidation”. The latest development marks a significant escalation in the fight between President Trump and Fed Chair Powell whose term is set to end in May. It follows President Trump’s decision last year to fire Fed Governor Lisa Cook with the legality of the decision set to decided upon soon by the Supreme Court. Oral arguments will be heard on 21^st January.   

The repeated attacks on the Fed’s independence to satisfy President Trump’s desire for lower rates continues to pose downside risks for the US dollar and supports our forecast for a weaker US dollar. However, it could backfire on President Trump if Fed officials dig in and keep rates on hold as an act of defiance to highlight the Fed’s ongoing independence in setting policy. It is more likely now that Chair Powell will stay on as a governor when his term as chair ends helping to curtail President Trump’s influence over setting policy. Even when the new Fed chair is appointed, other FOMC participants may now be less willing to support his call for lower rates. A development that would likely attract fresh attacks from the Trump administration. Less active Fed easing this year in defiance of President Trump would provide support for the US dollar.    

The US rate market already expects the Fed to leave rates on hold at least until the April FOMC meeting. Market participants have become more confident that the Fed won’t cut rates at upcoming policy meetings in January and March encouraged as well by the release of the latest nonfarm payrolls report for December. The report revealed that labour demand remained weak at the end of last year, but was not judged as weak enough to alter the Fed’s plans for a temporary pause in the rate cut cycle at the start of this year. Market participants put more weight on the bigger drop in the unemployment rate by 0.2 percentage points to 4.4% than further evidence of soft payroll employment. After downward revisions to prior months, it is harder to argue that private employment growth has been recovering after it averaged 29k/month in Q4 compared to 57k/58k in Q2 and Q3. Soft labour demand will keep pressure on the Fed to lower rates further this year. 

ATTACKS ON FED WILL BOOST RELATIVE APPEAL OF EUR OVER USD

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Snap election speculation in Japan triggers renewed weakness

The yen has underperformed alongside the USD dollar resulting in USD/JPY rising to a high of 158.20 overnight. The pair is currently attempting to break out of the consolidation range that has been in place since the middle of November. The next important resistance level is provided by last year’s high at 158.87. A break above would increase the likelihood of USD/JPY rising back above the 160.00-level and then testing the high from July 2024 at 161.95. Renewed yen weakness has been triggered by media reports that Prime Takaichi is seriously considering holding a snap Lower House election. According to ruling party members, one plan would involve dissolving the lower house of parliament immediately after it reconvenes on 23^rd January for a general election around the second week of February. Prime Minister Takaichi has not yet given any clear indication of the timing of a potential election.

By calling a snap election, Prime Minister Takaichi would be hoping to strengthen her grip on power in Japan by winning more seats for the LDP and potentially regaining an outright majority. The LDP together with its junior coalition partner the Japan Innovation Party, and three independent lawmakers currently hold a slim majority of 233 seats in the Lower House (465 seats in total). Prime Minister Takaichi would be hoping at the bare minimum to exceed the LDP’s disappointing  performance in the 2024 election when they won only 191 seats. Recent opinion polls indicate that the cabinet’s approval rating remains high between 60% and 70% encouraging snap election. However, public support for the LDP remains low. The LDP will be hoping that the “Takaichi” effect will be sufficient to win back disillusioned voters. 

If a snap election is held and strengthens Takaichi’s grip on power in Japan, it will encourage further yen selling in anticipation that it is likely to embolden her to double down on loose fiscal policy. In contrast, if a snap election backfires and the LDP continues to perform poorly, it could trigger a sharp reversal of yen weakness by undermining confidence in the sustainability of Takaichi’s reflation policies.  

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com