Bullish breakout for USD ahead of G10 central bank policy updates

USD/JPY: Japan steps up verbal intervention ahead of BoJ meeting

The US dollar has continued to trade at stronger levels overnight after the bullish break out at the end of last week when the dollar index closed above the 96.000 to 100.00 trading range that has been in place since Q2. The US dollar continues to derives support from rising energy prices in response to the Middle East conflict. The price of oil has risen further above USD100/barrel overnight reflecting unprecedented supply disruption in the Strait of Hormuz which remains effectively closed. It remains highly uncertain how and when the Strait will reopen. Unless supply comes back on stream soon, a higher price of oil will be required to destroy global demand to bring it back into balance with supply thereby reinforcing the negative energy price shock for the global economy. Over the weekend President Trump has called on countries to send warships to the Middle East to secure safe passage through the Strait alongside the US navy, and threatened to bomb “the hell out of the shoreline” and continually shoot “Iranian boats and ships out of the water”. He listed China, France, Japan, South Korea and the US among the nations he wanted to contribute naval forces. Additionally, he warned NATO would face a “very bad future” if members did not help to reopen the Strait. However, there still doesn’t appear to be a convincing plan to reopen the Strait. Furthermore, Iran’s new leader has committed to keeping the Strait closed. Recent developments have added to concerns that even if US military operations in the Middle East were to end soon, there is a high risk that Iran may continue to block the Strait to increase the economic cost which would act as a bigger deterrent for further attacks. We expect the US dollar to remain bid until the blockage in the Strait of Hormuz starts to ease.      

The stronger US dollar has helped to lift USD/JPY back within touching distance of the 160.00-level overnight. It has prompted a pick-up in verbal intervention from Japanese policymakers. Finance Minister Katayama warned that “we are watching developments with the utmost sense of urgency and stand ready to take bold measures if necessary. That is our stance on this matter”. The comments have helped to provide some temporary support for the yen and push back against the perception that Japan is more willing to tolerate a weaker yen in response to the energy price shock. Recent yen weakness is justified by the bigger negative terms of trade shock for Japan’s economy while the US dollar has strengthened broadly. The yen has actually held up better than most other G10 currencies in recent weeks. The week ahead will be important for yen performance with the BoJ holding their latest policy meeting on Thursday. The Japanese rate market is pricing in around 16bps of hikes for the following meeting in April so there are high expectations that the updated guidance this week will send a strong signal that the BoJ is moving closer to another hike. Higher energy prices and the weaker yen are expected to encourage another hike. Downside risks for the yen would increase if the BoJ displayed more caution over hiking rates citing concern over the potential hit to Japan’s economy from the negative energy price shock.   

SHORT USD POSITIONS CONTINUE TO BE CUT BACK

Source: Bloomberg, Macrobond & MUFG GMR

G10: Central Banks to provide more insight into response to energy prices

The week ahead will be an important first step in assessing how G10 central banks are likely to respond to the energy price shock with the RBA (Tues), BoC (Wed), Fed (Wed), BoJ (Thurs), SNB (Thurs), Riksbank (Thurs), BoE (Thurs) and ECB (Thurs) all scheduled to hold policy meetings. The RBA is expected to the first G10 central bank to hike rates in response to the energy price shock. It is helping the Aussie to strengthen at the start of this week after it dropped back below the 0.7000-level at the end of last week. The Aussie has benefitted from higher yields and commodity prices at the start of this year. However, a bigger hit to global growth from higher energy prices could begin to weigh more heavily on the Aussie further down the road if the Strait of Hormuz blockage is not resolved.     

For the other G10 central banks, we will be watching closely to see how their policy guidance responds to the Middle East conflict. They will have to acknowledge that upside risks to inflation from the energy price shock have increased in the near-term alongside downside risks to growth. However, it is likely to be too soon for most central banks to commit strongly to an updated path of policy action while developments in the Middle East remain highly uncertain. The Fed had are already signaled that they were not in a rush to resume rate cuts this year. A view that has likely been reinforced by recent developments even after the weak labour market data for February. In contrast, we expect the BoE and ECB to sound relatively more hawkish than the Fed. We expect a more unanimous MPC vote to leave rates on hold this week from the BoE after the narrow (5-4) vote last month. The BoE is likely to express more concern over persistent inflation risks again due to higher energy prices which has reduced scope for further rate cuts. Meanwhile, some ECB policymakers have already started to talk about the possibility of hiking rates if needed to lift the policy rate back into restrictive territory. It is unlikely that President Lagarde will commit to rate hikes this week but could open the door. However, we doubt that hawkish BoE and ECB policy updates will provide much support for the euro and pound against the US dollar given European economies are facing a bigger negative hit than the US economy from the energy price shock.        

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com