Political risks linger pointing to JGB and yen risks

JPY: Calls for PM Ishiba to resign will intensify uncertainty

USD/JPY was down by more than 1% yesterday as investors liquidated short yen positions due to the reduced political uncertainty after PM Ishiba confirmed in a press conference that he would continue in his position as prime minister. Investors believed that fact alone diminished the near-term risk of a leadership election and a new prime minister that would potentially increase government spending and destabilise the financial markets. It would also increase risks of a general election that could result in an even less stable government. PM Ishiba staying in power at least brings continuity in relation to trade negotiations – an important fact given the 1^st August deadline. Although with Ishiba in a much weaker position, what concessions can now be extracted from the US is questionable.

The question now though is – can Ishiba stay in power? A number of lower and upper house LDP members have today openly called for PM Ishiba to resign with one stating that it was “impossible for a leader not to take responsibility”. Former LDP Secretary General Akira Amari criticised Ishiba’s logic of remaining in power because the LDP is the single largest party. Another big hitter, former Digital Minister Taro Kono called for resignations if not by Ishiba than members of the senior executive. What may help PM Ishiba’s cause over the very short-term is the lack of time and the need for continuity in the trade negotiations with the US. Lead negotiator, Ryosei Akazawa and Howard Lutnick spent two hours in discussions in Washington in what the Japan cabinet office stated was “frank, in-depth discussions”. But so far there has been no positive comments from the US side to suggest a break-through took place.

What remains clear at this early stage is that the political uncertainty and the potential for a resignation will likely remain high especially if Japan fails to reach a satisfactory trade deal with the US by 1^st August. Yields in the US have been declining with the 30-year UST bond yield down 6bps from Friday through to today. The 30-year JGB yield is modestly higher as fears over fiscal expansion support yields. Finance Minister Kato today repeated the government’s opposition to any lowering of the consumption tax rate but was more supportive of abolishing the gasoline tax rate. Under this government it seems unlikely we will see any notable fiscal slippage so the JGB risk is more linked to PM Ishiba’s resignation and a shift in policy. But even then, JGB market moves will likely dictate the capacity for any new government to open up the fiscal purse. PM Ishiba previously promised no new JGB issuance to fund new spending.

In that regard, the FX markets will be closely watching for how PM Ishiba manages the fallout and his ability to remain in office. Many of the LDP executive positions are held for a year and many terms will expire in September which will be another period of risk for PM Ishiba. Whether it is a matter of days or longer, we see it as more likely that another change in leadership will happen. The gains for the yen yesterday were clearly position adjustments related to the build-up of yen shorts ahead of the election. There is no reason in this climate of political uncertainty for the yen to advance and we’d expect yesterday’ strength to more than reverse.

FURTHER JGB YIELD CURVE STEEPENING IS LIKELY

Source: Bloomberg, Macrobond & MUFG GMR

USD: Bessent calls for Fed enquiry

The US dollar was not just weak versus the yen due to the positioning unwind post-election but more generally as well as yields declined and the S&P 500 hit another new record high. One of the drivers of renewed dollar selling last week was the speculation on President Trump firing Fed Chair Powell. As we expected, this issue does not look like it will fade away and US Treasury Secretary Scott Bessent yesterday in a CNBC TV interview called for an enquiry into the “entire Federal Reserve institution” to assess whether it had been successful. Bessent criticised the Fed as “fear-mongering” over tariffs arguing that there has been “very little, if any inflation” from the tariffs. That is looking a little less credible given the latest inflation data showed core goods inflation, excluding autos increasing 0.55% MoM, the largest increase since November 2021. The inflation at this point in time is certainly less than was expected but if goods inflation is now about to pick up and we are set to see higher tariff rates from 1^st August, the inflation risks are certainly going to increase. Bessent again criticised the errors made over building renovations as the Fed released a virtual tour of the works being done.

As we stated in our FX Weekly on Friday (here), the episode of speculation on Powell being fired was the second clear example of market volatility created over the Fed’s independence and firing Powell – the first was on 21^st April, which was then denied on 22^nd April after fuelling big moves in UST bonds and the dollar.

Investor concerns didn’t last very long though and the Treasury International Capital data for May was released last week which revealed record buying of US portfolio securities by foreign private investors – purchases totalled a huge USD 288bn in May with purchases of USD 120bn worth of UST bonds and USD 104bn worth of equities making up the bulk of the inflows. Foreign official entities were also buyers in May. No doubt the Trump administration will be encouraged by the lack of lasting concern over firing Trump as evident in the May flow data that will likely encourage the administration further, especially with the S&P 500 at a record high.

The huge inflows do offer some counter-balance to the speculation of a demise in “US exceptionalism” that was popular when the dollar was falling sharply. Of course, as we point out, the surge in inflows is a function of the record trade deficit (the 12mth trade deficit is around USD 1.3trn, the 12mth portfolio securities inflow was USD 1.5trn) and hence an important part of the equation is the hedging behaviour of foreign investors and the performance of the dollar could certainly entice greater hedging appetite especially if/when the FOMC restart its cutting of the policy rate probably later this year.

US RECORD INFLOW FROM PRIVATE INVESTORS & A RECORD 12MTH TOTAL

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com