Verbal warning stepped up after USD/JPY breaks above 160.00

JPY: Verbal intervention & BoJ rate hike speculation provides support

The yen has strengthened overnight resulting in USD/JPY dropping back below the 160.00-level after hitting a high of 160.46. The main trigger for the yen rebound were comments from Japan’s currency chief Atsushi Mimura who warned that bold action maybe needed if the situation continues when referring to yen weakness. He added that he is hearing that speculative activity is picking up not just in the crude oil futures market, but also in the foreign exchange market. He finished by indicating that they are   prepared to respond on all fronts, and our focus is broad and comprehensive. The comments will encourage speculation that Japan is preparing to intervene in both the crude oil futures market and the foreign exchange market to support the yen. It follows hints last week from the government that it might step into the oil market in an indirect bid to support the yen. The yen has weakened modestly by around -2.3% against the US dollar since the start of the Middle east conflict in late February during which period it has been the fourth best performing G10 currency. Recent yen weakness has been encouraged by the higher energy prices that are delivering a negative terms of trade hit to Japan’s economy. 

At the current juncture, the BoJ appears to be placing more weight on the inflationary impact from higher energy prices and the weaker yen than the negative impact on growth keeping it on course to hikes rates again as soon as next month. That impression was reinforced by comments from Governor Ueda overnight when he spoke in parliament. He stated that the currency movements are a factor with a big impact on the economy and prices, and reiterated that the BoJ is watching currency movements closely. At the same time, the minutes from the last BoJ policy meeting on 18^th-19^th March were released overnight displaying hawkish policy signals. One board member noted that “if there are no signs of significant deterioration in the economic environment or in the wage setting stance of small firms, the bank will need to raise the policy interest rate without hesitation”. There was another hawkish comments from one board member who pointed to the potential need for rapid tightening, and said a rate hike, including its scale, needs to be considered by taking account developments in the Middle East, incoming economic data and anecdotal information. Governor Ueda had previously revealed after the March policy meeting that “slightly” more broad members put an emphasis on upside inflation risks stemming from the Middle east conflict rather than downside risks. The inflationary impact of the weaker yen was cited by one member who stated “monetary tightening could become necessary if the cost-push pressure is likely to intensify due to an excessive depreciation of the yen”. Overall, the developments highlight that Japanese policymakers appear increasingly prepared to intervene and/or tighten monetary policy to help support the yen. 

YEN SHORTS HAVE INCREASED BUT BELOW HIGHS FROM EARLY THIS YEAR

Source: Bloomberg, Macrobond & MUFG GMR

USD: Fresh Middle East supply concerns but limited spillover into FX market

The other major foreign exchange rates have remained relatively stable overnight with limited spillovers into the foreign exchange market from higher energy prices. The price of Brent crude oil has regained upward momentum at the start of this week hitting a high of USD116.75/barrel as it moves further above last week’s low of USD96.00/barrel although it still hasn’t broken above the high from 9^th March at USD119.50/barrel. Developments over the weekend have triggered renewed investor concerns over a broader and prolonged conflict in the Middle East that would be more disruptive for global energy supplies. Firstly, the Iran-backed Houthi rebels based in Yemen have entered the Middle east conflict by launching missile and drone attacks on Israel. It has created fresh concerns that they could also disrupt or block the Bab el-Mandeb Strait which is a strategic choke point at the southern end of the Red Sea. A development that would further disrupt global supply chains on top of the blockage of the Strait of Hormuz which remains effectively closed. According to media reports, if the Bab-el Mandeb became unsafe, ships would have to reroute around the Cape of Good Hope which historically increases transit time by 10-14 days and increases fuel and insurance costs.               

At the same time, market participants remain wary of the risk of the Middle East conflict escalating further which could include the US putting troops on the ground. It has been encouraged by comments from President Trump in an interview with the FT who stated that his “preference would be to take the oil” in Iran which would involve seizing the export hub of Kharg Island. The Pentagon has already ordered the deployment of 10k troops in the region that have been trained to seize and hold land. However, he went on to say “maybe we take Kharg Island, maybe we don’t. We have a lot of options”. On the other hand, he continued to indicate that diplomatic efforts to end the conflict are progressing well. He has set a deadline of 6^th April for Iran to accept a deal. Without a timely deal to end the conflict and re-open the Strait of Hormuz, risks remain tilted to the upside for energy prices as global supply shortages bite. It should favour further US dollar upside as well although it has failed to advance further in recent weeks which is perhaps an indication that a higher US policy risk premium has also been priced in.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com