FX Weekly

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USD recovers some lost ground at start of 2024

FX View:

The USD has staged a modest rebound at the start of the new calendar year following the heavy sell-off at the end of last year. The USD has derived support from the releases of the stronger NFP and CPI reports for December that failed to reinforce market expectations for Fed rate cuts as soon as in March. On the other hand they were not strong enough either to trigger a significantly hawkish repricing in the US rate market. US inflation has still clearly slowed in 2H of last year. The biggest mover amongst G10 currencies at the start of this year has been the JPY. Renewed JPY selling has been encouraged by expectations that the BoJ will delay their exit from negative rates until at least April. While at the same time, expectations for earlier rate cuts from the fed and other major central banks have been scaled back resulting in a re-widening in policy divergence with the BoJ. BoE rate cut expectations will be mainly tested in the week by the release of the latest UK CPI and labour market reports. Further evidence of disinflation would weaken the GBP.

A MIXED WEEK FOR THE USD

Source: Bloomberg, 13:35 GMT, 12th January 2024 (Weekly % Change vs. USD)

Trade Ideas:

We have closed our short EUR/JPY and EUR/NOK trade ideas with the loss on the EUR/JPY trade nearly offset by the gain on the EUR/NOK trade.

JPY Flows:

The MoF International Transactions in Securities data for December revealed Japanese investors purchased JPY 1,267bn worth of foreign bonds. 2023 was a year of sharp contrast to 2022 with sales in 2022 of foreign bonds totalling JPY 21.7trn reversing nearly entirely with purchases last year of JPY 19.6trn.

FX Correlation Heatmaps:

G10 FX rates have been strongly correlated to US rates over the past month both at the short and long end of the curve. The one exception has been USD/CAD which has the weakest correlation to US rates amongst G10 FX rates.

FX Views

JPY: USD/JPY higher for longer?

In our final FX Weekly of 2023 we stated that if the BoJ were to be cautious on rate hike guidance at its final meeting of the year then there was scope for the yen to weaken back but that any weakness would be relatively limited given the global backdrop is still conductive to yen strength. The yen did weaken in response to the BoJ meeting on 19^th December but then rebounded quickly fuelled certainly in part by positioning into the end of the year. The IMM positioning data indicates a sharp buy-back of yen with the combined yen short position from Leveraged Funds and Asset Managers falling by over 45% in three weeks. If there was now building speculation of a possible rate hike on 23^rd January, those gains may have been maintained but the tragic earthquake in Japan on New Year’s Day only reinforced the potential for the BoJ to maintain its cautious approach. The December BoJ policy meeting had already triggered a sharp decline in expectations of a hike in January and the earthquake only reinforced that change in expectations.  

The impact on the economy from the earthquake should be minor and fleeting. The Ishikawa prefecture does have some economic importance with machinery and semi-conductor manufacturing activities while food factories supporting local agriculture and fishing also exist. Fitch Ratings this week estimated there being no notable impact on Japan’s Life Insurance sector while the economic impact was estimated to be about one-twentieth of the much larger 2011 Great Earthquake and Tsunami. There will be a hit to Q1 real GDP but that should then reverse in Q2 assuming normal activities have generally resumed by then. It therefore means that the communications from the BoJ between the final BoJ meeting last year and the earthquake are still potentially important. Governor Ueda spoke on Christmas Day and again in an NHK TV interview on 27^th December. While emphasising in general that there was not yet enough evidence to conclude inflation was sustainable at the target level, the comments from Ueda made clear that progress toward that goal continues, which certainly indicates the potential for a rate hike by April, our current assumed timing of a hike.

Tokyo CPI data at the start of this week came in modestly weaker at the headline level (2.4% down from 2.7%, expected 2.5%) but the core and core-core readings were as expected. But the more important data these days perhaps is the cash earnings data given the emphasis on wages by the BoJ in determining the sustainability of inflation. In that regard, the cash earnings data is disappointingly unreliable at the moment.

USD/JPY CHANGE NOW IN LINE WITH BROADER USD

Source: Bloomberg, Macrobond & MUFG GMR

OFFICIAL CASH EARNINGS DATA WEAKER

Source: Bloomberg, Macrobond & MUFG GMR

A new data sampling pool means there is no continuity in the data and hence is not fully reliable. The overall MoM gain slowed from 1.5% in October to just 0.2% in November (expected 1.5%). The wide divergence from the consensus underlines the unreliability of the data. The old data sample release revealed wage growth at 2.0%, which suggests the data may still be consistent with the BoJ’s threshold for sustainable inflation. In any case, in the NHK TV interview, Governor Ueda stated in the context of determining if the 2% inflation target is achieved that “the key points are the wage hikes agreed to at the 2024 wage talks”, so the information the BoJ extracts on those talks and the outcome going into the April meeting will be the key factor.

From the start of 2024, the Nippon Individual Savings Accounts (NISAs) rules have been overhauled as the government attempt to entice Japanese households out of holding so much of their wealth in cash and deposits. The annual tax exemption is being raised from JPY 1.6mn per year to JPY 3.6mn and this can be utilised over a 5yr period amounting to JPY 18mn. Investment Trusts (Toushins) is where this flow into foreign markets can be monitored in monthly MoF flow data. The composition that goes abroad based on Toushin data is around 30%. The government’s target is to see this NISA fund double over the next five years from JPY 28trn to JPY 56trn. The change in dollars over 5yrs equates to USD 193bn. Assuming a 30% shift abroad we calculate roughly a flow per month of about USD 1bn. This is not ground-breaking of course but that figure is based on a linear line over 5yrs. There is highly likely to be a front-loading element to this and with the new changes now live, we may see some bigger FX impact in the early part of the year. We will monitor Toushin flows with the January data from the MoF due around 8^th -10^th of February.

The push-back in market expectations of a rate hike by the BoJ opens up a window of potentially four months of possible carry that is likely to draw investors back into long USD/JPY positions. The push-back has likely also increased the belief that Japan may miss the window to hike at all, which will further encourage yen selling. The BoJ meeting in January looks like a low-risk event at this stage given the unlikelihood that we get much change in the cautious rhetoric from Governor Ueda. More of the same seems most likely – progress toward price stability at the 2% goal is being made but not enough to take any monetary policy actions at this stage.

The return to carry will help support USD/JPY. The BoJ risk to that trade looks limited for now. The escalation of geopolitical risks could also help support USD/JPY. Higher crude oil prices is a yen negative while increased global inflation risks may leave the Fed a little reluctant to push a dovish narrative, at least over the short-term as inflation risks could be seen to be rising.

INVESTMENT TRUST OUTFLOWS PICKED UP IN H2 2023

Source: Bloomberg, Macrobond & MUFG GMR

GLOBAL CONTAINER FREIGHT COSTS RISING

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Will the BoE lag the ECB and Fed when cutting rates?

The GBP has outperformed at the start of 2024 when it has been the best performing G10 currency. It has resulted in cable rising back up towards the high from the end of last year at 1.2827 while EUR/GBP had dropped back below the 0.8600-level. The biggest mover has been GBP/JPY which has jumped from just below the 180.00-level back up to the 185.00-level. It marks a reversal in fortunes for the GBP after it underperformed in December. At the start of this year, market participants have been scaling back expectations over how early and deeply the BoE is likely to cut rates this year. The implied yield on the June and December 2024 three-month SONIA futures contracts have increased by around 18bps and 27bps respectively since late last year.          

The BoE is still expected to lag behind both the Fed and ECB when cutting rates in the year ahead. The first 25bps cut from the BoE is not fully priced until 20^th June MPC meeting. In comparison the first 25bps rate cuts from the Fed and ECB and fully priced in by their 1^st May and 11^th April policy meetings respectively. For this year as a whole, the UK rate market is roughly pricing in around 25bps less of cuts than in the euro-zone and US. The divergence continues to reflect investor concerns that there is a  higher risk of inflation proving more persistent in the UK. Those concerns were eased somewhat by reassuring evidence of slowing inflation and wage growth at the end of last year which contributed to GBP underperformance in December. In the week ahead, the release of the latest UK CPI (Wed) and labour market (Tues) reports will be scrutinized even more closely to better assess whether the disinflationary developments evident in December will be sustained. Inflation is running well below the BoE’s own forecast from the November QIR in which they forecast headline and core inflation ending last year at around 4.6% and 5.6% respectively. We expect significant downward revisions to the BoE’s inflation forecasts in February.      

The relative caution over the timing and scale of BoE rate cuts also partly reflects expectations that their room to make policy less restrictive will be curtailed by fiscal policy in an election year in the UK (click here). In recent weeks, UK Chancellor Hunt has announced that the Budget will take place on 6^th March and PM Sunak has suggested that he favours holding an election in the 2H of this year. The announcements have already fuelled speculation that government will take advantage of lower borrowing costs to provide more fiscal giveaways in the pre-election budget as they continue to lag well behind in the polls. While looser policy would provide more support for the UK economy that has been stagnating over the past year, it could discourage the BoE from cutting rates in the year ahead.

The releases of the latest UK CPI and labour markets reports in the week ahead will provide an important tests for the GBP. Further evidence of disinflationary pressures poses the main downside risk to GBP outperformance at the start of this year. 

WAGE GROWTH HAS STARTED TO SLOW

Source: Bloomberg, Macrobond & MUFG GMR

INFLATION SURPRISED TO DOWNSIDE IN NOVEMBER

Source: Bloomberg, Macrobond & MUFG GMR

Weekly Calendar

Source: Bloomberg, Macrobond & MUFG GMR

Key Events:

• There is a busy schedule of economic data releases in the week ahead. The main highlights will be the release of: i) the latest CPI reports from Canada (Tuesday), the UK (Wednesday) and Japan (Thursday), ii) the latest UK labour market report (Tuesday), iii) the latest Q4 GDP report and monthly activity data from December from China (Wednesday), and iv) the latest retail sales reports from the US (Wednesday), the UK (Friday) and Canada (Friday).     

• The release of the latest CPI reports from Canada and the UK are becoming more important as major central banks are close to policy pivots. Further evidence of slowing inflation will be required to support market expectations for the BoC and BoE to begin cutting rates as soon in April and June respectively. In the UK, market participants will be watching closely to see if the sharper drop in inflation in November was not just a one off. BoE rate cut expectations will also be influenced by the release of the latest UK labour market report. There have been more reassuring evidence recently that wage growth is slowing down helping to ease the BoE’s concerns over persistent inflation risks.  

• The release of the Q4 GDP report and monthly activity data for December is expected to confirm that China’s economy lost upward momentum heading into the end of last year. It will keep pressure on domestic policymakers to provide further stimulus to support growth in the year ahead.