Will G10 Central Bank updates bring an end to recent FX range trading?

CNY: Weak China activity data dampens expectations for currency strength

The foreign exchange market has remained relatively stable overnight ahead of a busy week for G10 central bank policy updates including the Fed (Wed), Norges Bank (Thurs), BoE (Thurs) and BoJ (Fri) who are all scheduled to hold policy meetings. Ahead of those policy meetings, the main focus at the start of this week has been the release of the latest monthly economic activity data from China which has revealed growth slowed for the second consecutive month. The slowdown was most evident for fixed asset investment where the annual rate of growth fell to just 0.5% in the first eight months of this year. It was the slowest pace of growth since August 2020 just after the initial negative COVID shock. The slowdown was driven by a deeper contraction in private investment (-2.3%) and sharper slowdown in public investment (from 3.5% to 2.3%). At the same time, retail sales growth slowed although more modestly to 4.6% YTD YoY in August.  After growing by 5.3% in 1H of this year, China’s economy is clearly slowing down in Q3. It still leaves the economy on track to meet the government growth target for this year of around 5%, but if the economy continues to slow it will encourage expectations for further policy stimulus later this year.

The National Bureau of Statistics (NBS) stated that China needs to “focus on stabilizing employment, enterprises, markets and expectations”. Noting “there are still plenty of instability and uncertainties with the external environment, and the economy still faces many risks and challenges”. The impact on financial markets in China  and Asia to the disappointing economic data releases has been muted. China’s equity market is continuing to trade close the highest levels in a decade, and USD/CNY remains close to year to date lows at just above the 7.1200-level. Over the past month, the renminbi has strengthened by around +0.8% against the US dollar after the PBoC consistently set the daily fix for USD/CNY lower in 2H August. However, it has been held at just above the 7.1000-level during the 1H  September. The loss of growth momentum in China may discourage domestic policymakers from allowing the renminbi from strengthening further in the near-term. 

USD POSITIONING AMONGST LEVERAGED FUNDS IS MORE NEUTRAL

Source: Bloomberg, Macrobond & MUFG GMR

USD/JPY: BoJ and Fed policies on track to diverge heading into year end

The US dollar is continuing to trade close to recent lows ahead of this week’s FOMC meeting. The US dollar is proving more resilient than expected to the sharp drop in short-term US yields since early August. The case for more active Fed easing was reinforced last week by the release of the BLS’s estimate of the preliminary benchmark revisions that suggested that total nonfarm payrolls were likely 911k lower than currently printed in the twelve months to March. Furthermore, the releases last week of the latest US PPI and CPI reports for August proved to be more benign than feared and are unlikely to deter the Fed from resuming rates this week. Forecasts for the core PCE deflator for August have been lowered to +0.2%M/M.

However, market participants remain reluctant to price in a much higher probability of the Fed delivering a larger 50bps cut this week. There are currently only 26bps of cuts priced in for this week’s FOMC meeting and 70bps for December. For short-term US yields to continue adjusting lower to provide a fresh trigger for another leg lower for the US dollar, the Fed would either have to deliver a larger rate cut this week and/or signal that larger rate cuts are on the table if the US labour market continues to weaken. The Fed’s policy rate is still well above their estimate of the longer-run neutral policy rate. The median projection for FOMC participants was set at 3.0% at the June FOMC meeting and central tendency range between 2.6% and 3.6%

On the other hand, the BoJ is expected to leave rates on hold at 0.50% at the end of this week. The recent pick-up in political uncertainty in Japan has dampened expectations for the BoJ to resume rate hike this autumn. The Japanese rate market is currently pricing in around 9bps of hikes by the October BoJ policy meeting compared to 12bps a month ago. Market participants will be watching closely to see if the BoJ provides any signal at this week’s policy meeting over the possibility of rate hikes resuming sooner than currently anticipated. A Bloomberg report released last week did indicate that the BoJ was still considering resuming rate hikes by the end of this year despite recent political uncertainty although Governor Ueda may remain cautious over sending a stronger signal this week over the timing of the next hike until political uncertainty has eased in October.

An opinion poll released by the Yomiuri Shimbun overnight revealed that Sanae Takaichi (29%) and Shinjiro Koizumi (25%) remain the two most popular candidates amongst the public to be the next LDP leader/Prime Minister. Amongst LDP supporters, Koizumi (33%) is more popular than Takaichi (28%). The ongoing political uncertainty is Japan is preventing the yen from strengthening against the US dollar, and benefitting from the recent narrowing of yield differentials between the US and Japan. Please see our latest FX Weekly for more details (click here).               

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com