USD/JPY: JGB & JPY sell-offs reinforced by supplementary budget

The US dollar has continued to trade on a stronger footing at the start of this week which has helped to lift USD/JPY back above the 159.00-level overnight. The US dollar rebound over the past week has been encouraged by the hawkish repricing of Fed rate hike expectations alongside higher energy prices. After hitting a low of 3.68% on 17^th April, the 2-year US Treasury yield has risen sharpy up to post-conflict high of 4.10% overnight. US rate market participants are moving to price in a higher probability of multiple Fed rate hikes in response to the energy price shock. The pick-up in US yields has contributed a broad-based sell-off for global bond markets and has put a dampener on buoyant investor risk sentiment. MSCI’s ACWI global equity index fell by -1.5% at the end of last week which was the biggest daily drop since 26^th March. The lack of progress in peace talks between the US and Iran to end the conflict and to re-open the Strait of Hormuz leaves the door open for a more disruptive stagflationary outcome for the global economy and financial markets. Media reports over the weekend have   stated that the US and Iran remain far apart on a deal with President Trump expressing frustration with Tehran. He warned “For Iran, the Clock is Ticking, and they better get moving, FAST, or there won’t be anything left of them. TIME IS OF THE ESSENCE!”. On the other hand, the semi-official Iranian news agency MEHR has reported that Washington offered “no tangible concessions” while seeking demands it failed to secure during the war. According to an Axios report, President Trump is scheduled to meet with his national security team again tomorrow” which alongside his threats to resume bombing in Iran have added to concerns that military action could resume if a deal is not reached soon.   

At the same time, the sell-off in JGBs and the yen has been encouraged as well overnight by reports that Prime Minister Takaichi has called on the Ministry of finance to compile an extra budget which is likely to require fresh debt issuance. She has asked Finance Minister Katayama to consider ways of funding including compiling a supplementary budget. It follows denials last week from Finance Minister Katayama that another supplementary budget would be needed. The planned supplementary budget is expected to fund emergency relief measures rather than provide economic stimulus, and the government is likely to issue fresh debt according to an unnamed government official cited by Reuters. With the current fiscal year having just only just started, it remains unclear how much extra tax revenue or unused funds are available, making further debt issuance increasingly likely. The government also has yet to finalize plans to temporary food tax cuts. There is no indication how big the supplementary budget will be yet, although the opposition DPP party have made a JPY3 trillion proposal. The latest fiscal developments in Japan have reinforced the sell-off in the JGB market with the 30-year yield jumping to a fresh high of 4.21% overnight and has now increased by around 50bps over the past month. Fundamental factors continue to favour further yen weakness and will keep pressure on Japan to intervene again to support the yen as the USD/JPY moves back closer to the 160.00-level. 

FISCAL CONERNS RE-EMERGE AS A HEADWIND FOR JPY PERFORMANCE

Source: Bloomberg, Macrobond & MUFG Research

GBP: UK political developments reinforcing downside risks for gilts & pound

In contrast to the US dollar, the pound is expected to remain on a softer footing in the week ahead reflecting heightened political uncertainty in the UK, and fears that the Labour party will shift to the left under new leadership. The gilt market and pound sell-off intensified at the end of last week after it was announced that Manchester Mayor Andy Burham plans to run in the by-election in Makerfield in an attempt to secure a seat as an MP so he can challenge Prime Minister Keir Starmer. According to reports over the weekend, Labour’s National Executive Committee (NEC) have agreed to allow Andy Burham to contest the seat. A Labour Party spokesperson said: Labour’s ruling body, the National Executive Committee has today given permission to Andy Burham to stand in the candidate selection process in the forthcoming by-election for the Makerfield constituency”. The NEC had blocked his previous attempt to stand as the Labour candidate in the Gorton and Denton by-election earlier this year.

It moves him one step closer to challenging the Prime Minister, although he still has to win the by-election which is far from a done deal. Labour expects a stiff challenge from Reform in Makerfield. In the May local elections, Reform won every council ward in the Makerfield constituency. So Andy Burnham will be relying heavily on his own popularity in Manchester and his pledge to make changes to the Labour policies at a national level if elected. He favours re-industrialisation, mass council house building, more public control of essential services, and steps to lower the cost of living. It has been reported that he has called for GBP40 billion of additional government borrowing to fund long-term capital spending. He has also floated the idea of taking defence spending out of the fiscal rules. The unfavourable domestic political developments come at a challenging time for the gilt market which is also facing the risk of much higher inflation from the energy price shock. We continue to hold a short GBP/CHF trade idea in the near-term.