USD extends gains with focus on Iran

USD/JPY: Iran and Takaichi speech has limited impact

The US dollar has gained modestly further with the focus on the risk of an imminent attack on Iran by the US as the build-up of military presence in the region continues. From the intra-day low recorded on Tuesday, Brent crude oil is now 8% higher and at a level not seen since July last year. President Trump stated that Iran has “10-15 days” to do a deal which could of course mean a lot less – weekends are the times in the past for US attacks and hence investors will likely be positioning for the possibility of an attack over the weekend. The build-up to when the US attacked Iran last year (22^nd June) saw crude oil surged nearly 20% in the eight trading days before and the dollar advanced by a little over 1.0%. The move isn’t yet that big in crude oil but similar in FX and with the positioning of late in FX, we could certainly see a scenario of further near-term gains.

USD/JPY specifically saw a larger move back then – in particular on the Monday in response to the attack and USD/JPY had advanced by about 3.5% in the eight-day period into the attack. The backdrop for Japan is a little different now with JGB sentiment improving in contrast to last year when there had been large sell-off in April and May. JGB sentiment now is improving given the concerted efforts by the government to ensure there would be prudent management of government spending.

PM Takaichi gave a keynote policy speech at the opening of the Diet today and again was very clear that the government would pursue a fiscal policy that is pragmatic with a focus on maintaining financial market stability. PM Takaichi stated that “we are not going to pursue a reckless fiscal policy that would undermine the markets’ confidence” but added that she would “keep hitting the growth switch – again and again and again”. How that is done while being fiscally responsible will be key.

There was much focus on defence and China and strengthening Japan’s capabilities so it is clear from this speech that tensions with China are set to remain elevated and could worsen. But the JGB market remained broadly stable with yields closing lower on the day although yields did tick a little higher in the aftermath of the speech. Softer CPI data today also helped. Still, JGB market stability can help contain any selling of the yen in response to geopolitical risks increasing. The fact that the Fed checked rates a little higher in USD/JPY in January may also act to contain any yen selling from here.  

CRUDE OIL RESPONSE TO IRAN ATTACK LAST YR MUCH LARGER THAN FX

Source: Bloomberg, Macrobond & MUFG GMR

EUR: January rally fully reversed as Lagarde speculation persists

(Please note this paragraph was edited to correct the text to reflect the fact that the ECB has already selected the VP to take over Luis de Guindos)

EUR/USD declined further yesterday and we have now seen a substantial reversal from the intra-day high of 1.2081 set on 27^th January. The drop now amounts to 2.5% and spot is now trading close to the opening level at the start of the year (1.1747). US dollar sentiment was dire in January and the nomination of Kevin Warsh as Fed Chair and stronger US data in February have been the key factors behind this full reversal in EUR/USD.

The euro correction lower has been reinforced by softer inflation data that has seen pricing for a rate cut from the ECB increase. The pricing is still modest but since mid-January there’s been about a 10bp swing lower in rates. Inflation in France has fallen sharply and the annual rate at just 0.4% highlights the potential for expectations of rate cuts to build if disinflation becomes more evident across other euro-zone countries. We continue to see downside risks to inflation given our expectations of a stronger euro, declines in crude oil prices and wage growth more consistent with lower inflation. Our current view is that the ECB keeps its policy stance unchanged but the risk to that view is clearly that we see a another cut this year. Italy and Belgium are examples of other countries where inflation is well below the 2% level (1.0% & 1.1% respectively).

There has been some market reports suggesting the weakening of the euro is partly down to the concerns over ECB independence given the possible early departure of President Lagarde that may be orchestrated in order to allow for the selection of a new president before the French presidential elections in April 2027. However, when compared to the scale of political interference in the US and the threat to Fed independence we doubt this will be a driver of EUR/USD selling. Furthermore, the selection of the ECB President is always political and whether done now or at the end of Lagarde’s term under a new French presidency it will involve deal-making and compromises.

Yesterday, we published an ad hoc macro piece covering the topic of Lagarde’s successor (here). As we highlight, the prominent runners mentioned are largely on the hawkish side with one (Hernandez de Cos) a more centrist option. The choice of who takes over from Vice President Luis de Guindos, whose term expires in May could prove important. In January, Boris Vujcic from Croatia was chosen to take over which leaves Hernandez de Cos still in the running – if the Portuguese Mario Centeno had been chosen it would have made is less likely that two southern Europeans to have held both the President and Vice President positions. It’s worth adding that President Lagarde has hinted today in a Wall Street Journal article that she intends to remain in position until the end of her eight-year term.

Still, while all of the speculation on who takes over could be market-moving, a divergence of inflation relative to the target will still be more important in shaping the  direction of monetary policy rather than who becomes President. A consensus-builder in a council of 27 has obvious advantages and the EU could ultimately pitch for someone more similar to Lagarde than a clear dove or hawk.

FRANCE YOY CPI FALLING SHARPLY TOWARD ZERO

Source: Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com