Japan yields continue march higher – JPY to outperform

JPY: Higher JGB yields as RBA cuts

Last Monday in response to the de-escalation in trade tensions between the US and China the yen weakened sharply as the dollar advanced as short-end yields in the US increased. From the close last Monday though, the yen has strengthened notably, by close to 3%, and is the best performing G10 currency since then. US yields have peaked out but remain elevated and have certainly not declined by anything close to what is implied by the drop in USD/JPY. US equities as well have continued their advance closing yesterday at the highest level since early March. So the drop in USD/JPY is telling in that is has not been driven by the usual US factors of yields and US equities.

That partly reflects the further hit to confidence by the Moodys’ downgrade that resulted in the dollar weakening across the board, even though equity investors do not seem that concerned. But the outperformance of the yen likely also reflects yield moves in Japan. Today, there were clear signs of a demand-supply mismatch in the JGB market with the 20-year JGB yield jumping 14bps and the 30-year yield by 15bps. The 20-year yield hit the highest level since 2000 while the 30-year yield hit the highest on record since first launched in 1999. A weak 20-year auction today was the catalyst for the bigger move at the longer end of the curve with the bid-to-cover at the auction (2.5 times) was the weakest since 2012.

The BoJ is seeking feedback from JGB market participants ahead of the June BoJ meeting when the BoJ will discuss the pace of retreat from the JGB market. The BoJ may need to consider a more cautious pace if the current price action was to persist.

The yen also gained after Finance Minister Kato confirmed that he planned to hold a meeting with Scott Bessent at the G7 Finance Ministers meeting in Canada this week. Included in those discussions would be the topic of FX. Given Bessent’s view that BoJ monetary policy is at the root of the dollar’s overvaluation versus the yen, the outcome may be seen as curtailing the BoJ’s appetite to shift to a more dovish stance. Secondly, the RBA cut rates today – the cut was expected but the dovish communications were not especially the acknowledgement that the RBA considered cutting by 50bps today. The 2-year yield in Australia is 16bps lower. With other G10 central banks still cutting it keeps the yen as the standout G10 currency where the messaging remains biased toward hiking again. Even if the BoJ end up not hiking again, it is very unlikely to revert to monetary easing which will continue to support the yen. We published a trade idea in our latest FX Weekly (here) shorting USD/JPY.

RISING LONG-TERM JGB YIELDS SET TO PUT FURTHER UPWARD PRESSURE ON JPY

Source: Bloomberg, Macrobond & MUFG GMR

GBP: EU-UK deal sees initial GBP underperformance  

The less favourable risk conditions in the financial markets yesterday in response to increased concerns over the fiscal outlook in the US and continued concerns over possible diminishing confidence in US assets saw the euro outperform the pound although the outperformance faded as the day unfolded with equities in the US rallying from the lows at the start of the US trading day. What was clear was that the announced EU-UK deal didn’t have much market impact with the details having little impact in shaping investor expectations on the outlook for either economy. While economically the financial markets have not responded to the deal, politically this could still mark an important turning point after years of acrimony. EC President Ursla von der Leyen stated that it marked a “new chapter” in EU-UK relations.

But the most contentious politically for PM Starmer at home will be granting access to EU fishing in UK waters for an additional 12 years. ONS data indicated that in 2023 the gross value added of the fishing industry was just GBP 862mn, representing 5.7% of total value added of the agricultural sector. Fishing alone amounted to 0.03% of economic output. PM Starmer has argued that the easing of veterinary rules that will boost UK exports of food and drink to the EU and would therefore easily offset the negative impact on fishing. While that looks like a valid argument, it won’t stop Reform taking advantage of this and will only reinforce Reform support in rural coastal regions across the UK. PM Starmer has tried to offset this risk related to fishing by promising GBP 360mn of investment for fishing and tourism in coastal areas. A recent YouGov poll published on 16^th May revealed that 22% of respondents now expect Nigel Farage to be the next PM versus 14% who stated PM Starmer. The next election in the UK is not until 2029 and hence the near-term political risks from this announcement are negligible but policies to boost economic growth will be crucial to curtail the risk of Reform being the largest party in a new coalition government.

Nearer-term, GBP direction will be dictated by the incoming data which will not be influenced by this EU-UK deal. The CPI data for April, to be released tomorrow, is likely to see a notable jump from 2.6% in March to an expected 3.3%. The NICs tax increase went live in April and energy prices jumped and other utility bill and tax increases also went into effect. The NICs impact is more difficult to predict and any upside inflation surprise tomorrow will likely be due to companies passing on more of the cost of the tax. The Institute for Fiscal Studies estimated that the cost for an employee on a median salary will increase by 7.1% due to the NICs. That could result in a larger impact and a more widespread increase in inflation.

A consensus 3.3% CPI YoY gain will likely be met with relief. That’s the estimate of what the BoE expects as well and would help the BoE deliver the two rate cuts currently priced. An upside surprise would likely give GBP a boost although negative growth implication would likely mean the impact would fade quickly. BoE Chief Economist Huw Pill will speak at 9am this morning.

RATE SPREADS LESS IMPORTANT FOR GBP/USD THAN PREVIOUS GIVEN USD CONFIDENCE ISSUES

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com