China-Japan dispute encouraging yen selling

JPY: China-Japan geopolitical tensions in focus

It has been a quiet start to the week in the foreign exchange market with the US dollar continuing to consolidate at higher levels at just above the 100.00-level for the dollar index. The dovish comments from New York Fed President Williams on Friday leaving the door open to another rate cut in December have temporarily dampened the US dollar’s upward momentum, and helped US AI/tech stocks to rebound. The Nasdaq composite equity index rose sharply yesterday by 2.7% extending its rebound from the intra-day low on Friday up by almost 4.5%. However, the rebound in US equity markets has not been sustained during the Asian trading session. The Nikkei 225 equity index initially opened higher by just over 1% after re-opening following yesterday’s holiday in Japan but has since given back those gains. Recent weakness in the Japanese equity market reflects in part investor concerns over the geopolitical spat between China and Japan. It has been reported overnight that Japanese Prime Minister Sanae Takaichi spoke with President Donald Trump by phone at his request, and he briefed her on his phone call with Chinese President Xi Jinping. The phone call between Presidents Trump and Xi reportedly lasted an hour during which President Xi told President Trump that Taiwan’s return to China was “an integral part of the post-war international order”. Market participants are hoping that the talks will help to prevent geopolitical tensions between China and Japan from escalating further and reduce risks to the recent 12-month extension of the US-China trade truce. It follows China’s decision to write a letter to the UN accusing Japan of violating international law by suggesting its armed forces could be drawn into a Taiwan conflict.

However, there have been reports overnight that China has asked airlines to extend Japan flight cuts until March. According to Bloomberg, cancellations of Chinese flight bookings to Japan had accelerated prompting airlines to begin cutting capacity. There had already been reports that state-owned agencies were cancelling tours and warning against visiting Japan. The hit to tourism continues to pose downside risks to Japan’s economy. According to the Japan National Tourism Organization, the number of Chinese tourists to Japan rose by 40.7%Y/Y to 8.2 million between January and October. Spending from Chinese visitors accounted for around 24% of the total for all international visitors coming in at JPY1.6 trillion between January and September. It is another source of economic uncertainty which could add to the BoJ’s caution over resuming rate hikes and has likely played contributed to the yen’s recent weakening trend. Nevertheless, the Japanese rate market has still moved overnight to price in a higher probability of the BoJ hiking rates at either the December or January policy meetings after re-opening following yesterday’s holiday in Japan. The Japanese rate market is now pricing in around 9bps of hikes by December and 22bps by January encouraged by hawkish comments from BoJ officials over the past week. At the same time, Growth Strategy Minister Kiuchi continued to verbally intervene to support the yen by stating that the Japanese government is watching currency movements, including speculative activity, with a high sense of urgency. For intervention to be more effective at reversing the yen weakening trend, it will need to be backed up by the BoJ resuming rate hikes as well. 

CHINA & JAPAN HAVE BOTH BENEFITTED FROM WEAKER CURRENCIES

Source: Bloomberg, Macrobond & MUFG GMR

EUR: Budget uncertainty set to persist heading into year end

The euro is continuing to trade just above support at around the 1.1500-level against the US dollar. EUR/USD has been consolidating between 1.1400 and 1.1800 during the second half of this year. Heightened political uncertainty in France first triggered by former French Prime Minister Bayrou losing a vote of confidence at the start of September has had only a modest negative impact on euro performance in recent months. It has been a similar story in the French government bond market. The yield spread between 10-year French and German government bonds hit a high of 0.86% on 7^th October but has since dropped back to around 0.75%. In comparison the yield spread was trading between 0.65% and 0.70% heading into the summer.          

Political risk priced into financial markets has subsided over the past month after Prime Minister Lecornu survived two votes of no confidence in the middle of October. It has given him some breathing room to work on passing a budget for next year. However, he still faces a formidable challenge to reach a compromise budget deal. The difficult path ahead was evident over the weekend when the National Assembly voted against the tax chapter of the bill in the first reading. The rejection of the revenue part of the budget means the original bill advances to the Senate. The government has committed to maintain amendments that have been approved so far. The rejection is unlikely to cause any major disruption in the near-term. The Senate is meant to conclude its works on the Social Security Budget by 26^th November and general Budget by 12^th December. The government then has until 12^th December to hold a vote on the Social Security Budget and 23^rd December for the general Budget. It has ruled out using Article 47 to force through the Budget given it would likely result in it losing a vote of no confidence. Last year’s budget can be rolled over as an emergency measure to buy more time to pass a budget for next year in early 2026.            

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com