US dollar momentum remains compelling for now

USD: Higher yields and weak global growth concerns fuel gains

Front-end yields in the US continue to advance higher relative to the euro-zone which has helped maintain the downward momentum in EUR/USD. The move higher in US yields is not really data-driven with no top-tier data to drive the market since the jobs data last Friday. The jobs report did result in yields drifting higher given the data was not a game-changer in terms of re-igniting speculation of Fed rate cuts coming sooner than expected. As we have stated here before, the simple passing of time with no evidence of US economic activity weakening notably is enough to lift yields given the rate cuts priced for 2024. The Dec 2023-2024 fed funds futures spread narrowed by 7bps yesterday to 102bps. The fact that another jobs report has failed to signal a sharp drop in labour demand seems enough for now to push yields further higher.

The upward momentum for yields in the US was helped by the sharp jump in crude oil prices after Saudi Arabia released a statement confirming that it would maintain the 1mn barrels per day production cut until December (a 3mth extension). Output will be held at 9mn barrels per day for six months and even with the growth outlook subdued the confirmation was enough to spark the jump. NYMEX crude oil is now up over 10% in eight trading days. The scale of such a move can have implications if extended further. In just two months NYMEX is now up nearly 25% which will start to impact m/m headline inflation levels. On an annual basis, crude oil prices have returned to similar levels. But this development must also be viewed in the context of some supply-side developments in natural gas with the two Chevron offshore facilities potentially shutting down as a two-week strike commences on 14th September. Add to this the collapse of the grain export agreement between Russia and Ukraine, the curtailment by India of the export of certain rice and concerns over El Nino weather predictions pointing to potential food supply issues. All of these factors could put upward pressure on food and energy inflation just as global central banks consider pausing tightening cycles.
Of course this could end up being a bigger inflationary risk development for Europe than for the US. Certainly natural gas price moves would be more abrupt here than in the US and that putting downward pressure on EUR/USD adds to inflation risks. These risks are building and could worsen quickly so these developments will likely be part of the discussions at the ECB Governing Council meeting next week. We will have updated forecasts as well (which may not incorporate some of these moves) and certainly if food and energy risks build further in the short period to the meeting, it could well sway the ECB to hike. That isn’t our view but these recent developments could sway the Council to add an insurance hike rather than pause. The OIS market only has 6bps of tightening priced for next week which seems low to us. A surprise hike would also help to reverse some of this US dollar strength as well.

USD / 2YR YIELD CORRELATION BACK TOWARD RECENT HIGHS

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Rhetoric intensifies once more from Tokyo

The positive US dollar momentum was clear to see in USD/JPY yesterday with a move to a new high of 147.80, which was breached slightly earlier this morning. Today’s high at 147.82 is the highest level since 4^th November last year. Rhetoric from Tokyo had picked up during August after initially breaking through 145.00 but then a period of relatively stability saw rhetoric opposing yen weakness dialled down.

That has now changed however after yesterday’s move and Vice Finance Minister for International Affairs, Masato Kanda, spoke today and stated that the MoF was monitoring FX with a “high sense of urgency” adding that it would not “rule out any options” if the depreciation continued. The yen has rebounded and is the top performing G10 currency today. In August we highlighted our scale of tone of rhetoric from Tokyo in regard to signalling possible intervention (here) based on 2022 comments ahead of intervention in September and October and estimated then that on a scale of 1-8 (with 8 high chance of intervention) comments then put us at about a 6 earlier in August.
The comments used today – in particular referencing not ruling anything out – signals a higher threat of imminent intervention given this was the phrase used just prior to intervention last year. So certainly based on previous comments today’s comments are consistent with being at an 8 on the intervention scale.

The only note of caution here is the fact that to intervene now would certainly look more like protecting a level (150.00) rather than intervening under the guise of curtailing unwarranted levels of volatility and disorderly price action. We also have the G20 taking place in India at the end of this week and Japan may be reluctant to go into that summit under a threat of being accused of intervening to protect a particular level. China and its actions could also be important in any decisions on intervention. If China was to suddenly allow USD/CNY to jump notably above the 7.3000-level (becoming an increasing risk) that would undoubtedly create volatility more broadly and could be the catalyst for action. We can certainly expect Japan to push for a coordinated communication from G20 against excessive currency moves. The rebound of the yen is unlikely to last based just on these comments and the resolve of Tokyo is likely to be tested given the broad-based strength of the US dollar at the moment.

ALERT LEVELS BASED ON 2022 COMMENTS 1-8 – TODAY SIGNALS LEVEL 8

Source: MUFG Global Markets Research; Tokyo

KEY RELEASES AND EVENTS

Source: Bloomberg