Major currencies in holding pattern ahead of NFP report on Thursday

JPY: Japan GDP contraction supports expectations for policy support

It has been a quiet start to the week for the FX market with the major currency pairs largely unchanged. One of the main events for FX market this week will be the release of the delayed US nonfarm payrolls for September. The Bureau of Labour Statistics have confirmed that the report will be released on Thursday. Market participants and the Fed will scrutinize the report closely to better assess the health of the US labour market ahead of the next FOMC meeting in December. After the hawkish comments from Fed Chair Powell at the last FOMC meeting pushing back against market expectations for a cut in December, the US rate market now judges that a third back-to-back 25bps cut is more of a toss-up. There are currently around 11bps of cuts priced in for the December FOMC meeting. The release of the minutes from the last FOMC meeting on Wednesday will also provide further insight into how divided participants are over delivering further policy easing in the near-term. The dollar index is still trading around +0.7% higher than prior to the last FOMC meeting in October but gave back some of those initial gains over the past week after the dollar index failed to break above resistance from the 200-day moving average that came in at just above the 100.00-level. Our forecasts for the US dollar to weaken further heading into year-end rest on the assumption that US labour demand remains weak leaving the door open for further Fed rate cuts.

The yen underperformed alongside the US dollar and the pound last week undermined at the start of the week by the rebound in US tech stocks and re-opening of the US government that contributed to an improvement in risk sentiment. However as the week went on the rebound in US tech stocks quickly petered out with the Nasdaq composite index hitting fresh lows on Friday. A deeper pullback for US tech stocks could provide more support for the yen, and is one potential trigger for a short squeeze. Yen short positions have been built up over the past month to more elevated levels to reflect expectations that the new Takaichi-led government will put in place looser fiscal and monetary policies to boost growth. It has helped to lift USD/JPY back up to the 155.00-level as it moves closer to levels where Japan last intervened in July 2024 between 157.00 and 162.00. Market expectations for the BoJ to resume rate hikes this year in December have declined over the past week. Ther are currently around 8bps of cuts priced in for the December meeting compared to 12bps a week ago.

The release at the weekend of the latest GDP report from Japan for Q3 will further encourage market expectations for bigger fiscal stimulus and delayed BoJ policy normalization. The report revealed that Japan’s economy contracted by an annualized rate of -1.8% in Q3 which was a little better than the consensus forecast for a decline of -2.4%.  It was the first quarterly contraction in GDP since Q1 2024. The contraction was driven by weakness in residential investment which subtracted -1.4ppts from growth and net exports which shaved off 1.0ppt. Stricter environmental standards disrupted housing construction while trade disruption weighed on export growth. On the plus side, domestic demand stripping out residential investment remained solid. At the same time, there are increasing concerns at the start of this week that the escalating confrontation between China and Japan would pose downside risks for Japan’s economy as well. Japan is reportedly dispatching a senior diplomat to China today to help smooth relations after China’s state media threatened “substantive retaliation” in response to comments from Japanese Prime Minister Takaichi’s comments suggesting Japan could take military action if China attacked Taiwan.        

GILT MARKET IN FOCUS AFTER HEAVY SELL-OFF AT END OF LAST WEEK

Source: Bloomberg, Macrobond & MUFG GMR

GBP: All eyes on gilt market after heavy sell-off at the end of last week

Market participants will be watching closely to see how the gilt market performs at the start of this week following the heavy sell-off on Friday (click here). The 30-year gilt yield jumped higher by around 17bps reflecting investor unease over the government’s decision not to raise income tax in the upcoming Autumn Statement scheduled for 26^th November. The sell-off initially reflected concerns that the government’s decision may have been  driven by a desire to preserve political stability in the Labour party after fresh speculation over the past week of potential leadership challenges. A decision to raise income tax would have broken the Labour party’s manifesto pledge, and would be more politically damaging when their support has already fallen sharply and PM Starmer’s approval ratings are among the worst for a sitting prime minister minister. For these reasons it is understandable why the Labour party would seek to avoid an income tax if possible.

The good news for the Labour party were reports that the OBR has upgraded its economic forecasts which now show a smaller fiscal hole to fill of GBP20 billion rather than up to GBP30 billion. The smaller fiscal hole allows the Labour party to avoid raising income tax, and they will instead focus on a range of alterative tax hikes. While news of a smaller fiscal hole would normally be supportive for gilts and the pound, it has not fully provided reassurance that the government’s decision was not politically motivated. Fiscal tightening measures without an income tax hike is viewed as less credible by market participants reinforcing negative pound sentiment in the near-term.        

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com