GBP & JPY have been driven by fiscal concerns

JPY: JGB & JPY sell-off has eased after supplementary budget details released

The yen has continued to trade at weaker levels during the Asian trading session alongside the US dollar which has corrected lower in response to dovish comments from New York Fed President Williams who signalled he still sees room for another rate cut in December. Market expectations for a December Fed rate cut have been supported in recent days by the run of softer US economic data ahead of the Thanksgiving holiday today. Core PCE inflation now appears  et to undershoot the Fed’s year end forecast providing further justification for dovish FOMC participants to push for another rate cut in December. The US rate market has subsequently moved to more fully price back in a December cut. There are currently 20bps of cuts priced in compared to only around 9bps on 20^th November. A temporary pause in the Fed’s rate cut cycle is viewed as more likely at the start of next year in January and March. If the Fed cuts rates in December as we expect, it is likely to be a hawkish cut with more dissents from FOMC participants setting up a pause early next year.

The yen has remained weak alongside the US dollar at the start of this week. The main development yesterday were media reports revealing Japan’s government plans to issue an additional JPY11.7 trillion of bonds to fund the supplementary budget totalling JPY18.3 trillion according to a document seen by Bloomberg. The rest of the supplementary budget will be plugged by tapping JPY2.9 trillion in tax revenue surpluses, roughly JPY1 trillion in non-tax revenue, and about JPY2.7 trillion in unused funds from the previous fiscal year to limit borrowing. The additional JPY11.7 trillion of bond issuance is consistent with the pledge from Prime Minister Takaichi that total bond issuance for this fiscal year will remain below last year’s total of JPY42.1 trillion coming in at JPY40.3 trillion. JGB yields have stabilized at higher levels since details of the supplementary budget were released after hitting year-to-date highs on 20^th November. While the supplementary budget details have eased some of the fiscal concerns in Japan, the yen remains vulnerable to further weakness in the near-term.     

If the yen continues to weaken heading into year-end it will increase the likelihood of the BoJ resuming rate hikes in December. Our colleagues in Tokyo have recently brought forward their forecast for the next BoJ rate hike to December from January, which they expect will be important in lowering USD/JPY back toward the 150.00-level by year end. A view that is becoming more popular among market participants as well. The Japanese rate market is currently pricing in around 13bps of hikes by December compared to only 5bps a week ago. The hawkish repricing of BoJ rate hike expectations has been encouraged by recent comments from BoJ officials including Governor Ueda who indicated he was monitoring the inflationary impact from the weak yen. However, market expectations for an earlier hike were not given further encouragement overnight from dovish BoJ member Asahi Noguchi. He suggested a measured, step-to-step approach to policy adjustments. The comments were less hawkish than in September when he stated the need to adjust rates was rising “more than ever”. 

UK FISCAL CONCERNS EASE HELPING GBP TO REBOUND

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Temporary relief as gilt market sell-off avoided

The pound staged a relief rebound yesterday after the UK government released details of their own budget. There was initial relief amongst market participants that the Autumn Statement did not trigger a sell-off in the gilt market. The scaling back of short pound positions built up ahead of the Autumn Statement has helped to lift cable to a high overnight of 1.3269 while EUR/GBP has dropped back to  0.8750. While the initial relief rally for the pound is understandable in light of positioning, we are not convinced that the bullish momentum will last long.    

The lack of any material negative policy surprises in the budget does not provide justification for a sustained reversal higher for the pound. We expect the market focus to switch back soon to the prospect of the BoE cutting rates again in December weighing on pound performance heading into year end. Yesterday’s budget did not change our forecast for the BoE to cut rates in December. At the margin we would argue it is supportive given the government’s policies will help to lower inflation next year and represent additional fiscal tightening. Admittedly, the tax hike measures were back-loaded so will have less impact on dampening growth in the coming years. We expect continued loosening in the UK labour market and slowing wage growth to create more room for the BoE to lower rates to 3.25% by next summer.                

The budget has been criticised for putting off making difficult decisions on the need to cut government spending, pushing back tax hike measures until closer to/after the next election casting doubt on whether they will be implemented as planned, and lacking clear policies to boost growth. It is viewed as more of a political exercise to appease Labour MPs and reduce pressure on the leadership of the party. The initial favourable market reaction also further helps to reduce the risk of an immediate leadership challenge. Please see our focus report for more budget details (click here).     

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com