Global Yields, Asian Currencies, USD weakness vs JPY weakness
Yesterday saw one of the rare occasions when European 10- year real yield fell faster than nominal yields. Data wise, there was little to explain this move as data globally have stayed strong. US Senator Lindsey Graham not ruling out the US going to war with North Korea had little impact on Asian currencies and, with investors happy to buy risk-related higher yielding assets, we instead attribute current market behaviour to strong liquidity conditions and Secretary of State Tillerson’s more conciliatory tone towards North Korea. US banks deploying their balance sheets to reach for higher yields, plus the US Treasury reducing its cash balance ahead of reaching the debt ceiling in September, have pumped additional funds into the system, keeping risk assets supported. After a meeting with Minority Leader Schumer and Treasury Sec Mnuchin, Senate Majority Leader McConnell said there will be a vote on the debt ceiling ‘next month or so’ suggesting that the US should ‘never ever’ default on its debt. USD cross-currency basis spread arbitrage seems to be working again, converting onshore USDs into offshore USD liquidity, which we view as an important condition for keeping the risk rally alive.

The US auto cycle seems running tired with yesterday’s car sales data (moderately) disappointing again. Consequently, the Dow Jones transportation index – a bellwether of the equity market – has fallen 6.4% from its June top. However, a similar signal emerged in March and did not prevent the equity market from continuing to work higher. This is because European and US equity markets continue to be supported by strong earnings releases. Yesterday’s sharp 3.5% fall in oil prices tells a similar story. API inventories released overnight showed a surprise 1.8m barrel rise in US crude inventories, and OPEC output was reported to have risen in July, according to Bloomberg and Reuters surveys. The commodity market seems split between those commodities facing inventory and overcapacities (such as energy) and other industrial raw materials (such as copper and iron ore) where recent growth in demand have led to higher prices. For risk markets to turn lower we need inflation to pick up, which we only expect late this year going into 2018. Yesterday’s core PCE release coming in at 1.5%Y is consistent with the risk rally extending further from here.

With real DM yields falling rapidly, narrowing interest rate differentials, one would expect the JPY to continue its recent rally. Instead, the JPY has weakened overnight with EURJPY trying to break above its 200-week MAV. EURJPY is one of the currency pairs most sensitive to trends, rarely spending too much time within a corrective pattern. Over the past 10 years EURJPY has crossed its 200-week MAV only three times; all occasions were followed by significant moves. Important to the future path of the JPY will be the policy stance of the BoJ. Some market participants view the JPY as the next EUR with respect to the BoJ changing its stance in light of economic recovery. We disagree with this view. Overnight it was the BoJ’s Funo suggesting the BoJ must maintain its aggressive monetary easing stance to achieve stable 2% inflation, which would create room for lowering real borrowing costs when the economy slumps. USDJPY has formed a tradable bottom and is expected to rally from here.