Global FX, FED speakers and possible Japanese policy response


Japan’s release of weak July industrial production data falling by 3.8%Y showing its worst performance since February has completed a string of disappointing data releases from Japan, which could increase speculation of an aggressive monetary policy response. Both, the BoJ and the Fed will meet on the 21st of September and while the market has upgraded the probability for the Fed to act in September to 37% the odds are more likely for the BoJ conducting additional easing steps. In the forefront of these meetings USDJPY has the potential to break higher testing the 107/108 before falling back again. EURJPY has the potential to see 120. The biggest mover could be GBPJPY rallying to 145helped by UK data strength and investors taking a more relaxed view on Brexit.

The three policy measures recently used, namely negative interest rates (NIR), QE and intervening by buying private sector assets did not develop desired effects and we remain skeptical concerning the ability of these instruments to weaken the JPY even if used aggressively. The BoJ may have to enter new progressive steps to boost local inflation expectations allowing real JPY rates to fall. Given the ineffectiveness of BoJ policy, markets may speculate that the BoJ may turn more innovative, easing monetary policy beyond the measures currently in use. This morning BoJ’s Funo suggested that he does not see limits nearing to monetary easing, while PM Abe’s adviser Hamada now sees Abenomics ‘not doing well’ reiterating the BoJ could purchase foreign bonds and monetise sovereign debt.

The Fed’s recent hawkish tone may be echoed today when Evans and Rosengren speak. Yesterday saw US August consumer confidence rising towards an 11-month high supporting the better reading of our ARIA indicator. Last week’s release of US July durable goods orders showed a second consecutive improvement with its non-defence, non-aircraft category leaving the impression that investment spending may be heading towards improvement. Frequent readers of our research know that we are especially skeptical concerning the supply side of the US economy highlighting poor productivity and profitability trends which, in conjunction with the renewed rise of private sector leverage, has the potential to challenge an economic recovery should rates rise too early. We stick to this view.

However, there are time lags involved with rising real rates leading to deleveraging.For now markets have the impression that the US economy may be strong enough to withstand a rate rise. In August US financials outperformed the index suggesting that the risk rally may have further legs to go.For the risk rally to derail we may need markets to conclude that the ‘Fed made a mistake’ i.e. the Fed hikes rates and the US economy slows down. The recent string of better US data leaves the impression that we are nowhere near such type of outcome and as long as US data remain strong, the US front end of the curve will not budge lending support to the USD against currencies sensitive to front end yield differentials. The JPY belongs into this category.

We underline our bullish calls for the EUR and CHF based on our assessment of the capability of European financial institutions exporting capital. The SNB’s continued intervention adds to EUR support, explaining why downbeat EMU inflation data had a very limited impact on the EUR. Our bullish GBP case is more of tactical nature based on better UK data readings. Upcoming PMI data should show a bounce back. Overnight saw UK August consumer confidence bouncing back from -12to -7. Against long EUR, CHF and GBP positions we trade KRW, AUD and CAD shorts. Copper prices easing back to June levels and iron ore rolling over will support these trades too.