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Global FX, the Fed, USDJPY and GBP

 

We stick with our trading strategy of selling USD vs. high-yielding currencies. The Fed showed yesterday that it is open to a hike in December (market probability at 61%) this year but following it with a reduced pace of hikes. It is the pace of hikes that is important for risky assets, therefore we see no immediate risks to our long AUD, NZD, BRL and IDR views. The Fed brought down the dots for the coming years to 1 hike this year (vs.2in June),2 (vs.3)next year,3(vs.3) in 2018,and 3in 2019, which should support our USD view. However, there is a split among the FOMC, with three dissenters in favour of a hike (Mester and Rosengren joining George). The main message we took was the Fed remains patient and, as the statement notes, is “wait[ing] for further evidence of continued progress towards its objectives”. This puts the focus on upcoming data and whether it will be enough to give the confidence to deliver another rate hike.

The shift in focus from using monetary policy stimulus to combining with fiscal stimulus is increasingly forming part of the market debate. Yesterday it was the BoJ keeping rates on hold but changing its QE programme to target the yield curve that failed to inspire markets into thinking inflation will actually rise, supporting our view that in Japan the focus has to come from the fiscal side now. Countries with already low interest rates and a flat yield curve, so the transmission mechanism towards a weaker currency is broken, are the ones that are most likely to shift focus as the monetary toolbox appears increasingly empty. The ECB’s Draghi was increasingly emphasizing that Eurozone governments should use fiscal room if they have it.From an FX perspective, the US is not in this camp at all as relatively high US bond yields mean there is room for USD to still weaken from an easier path of policy from the Fed.

It has become increasingly clear that yesterday’s actions by the BoJ were not sufficient to raise inflation expectations. We have outlined several times that it would need increased debt-funded fiscal spending to even make that a reality, therefore the ball was never in the BoJ’s court, it was always with the MoF. Maybe the certainty that the government can borrow for 10 years at 0% can help buthere we will have to see. The government has only just passed a JPY7.5trn increase in real spending and is focused on other measures such as ratifying the TPP, therefore our economists’ base case is that BoJ policy rates stay on hold for now and there is little change in stance from the government. Today it is also the USD side working against the pair, with a dovish Fed now limiting the upside in USDJPY in the coming days. We closed our long EURJPY position yesterday and now wait for a change in circumstances before reconsidering this trade.

The UK is also somewhere markets may start to discuss fiscal spending as part of the government’s response to Brexit. We will likely hear more in the run-up to the November Autumn Statement, but today the market’s focus will be on monetary policy. GBP is one of the currencies we prefer not to trade as part of our general bearish USD strategy, given the uncertainty around business investment after the Brexit vote and the impact it could have on economic data. The BoE’s Carney will give a lecture in Berlin today and we will be looking for signs on whether he thinks there is need for another rate cut soon. A key level to watch to the upside for GBPUSD is the 50DMA at 1.3147.

 

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