Yields on core European bonds went for a slide yesterday as prices rose in response to the ECB's decision to leave its QE programme unchanged – for now at least. Elsewhere, the USD continues to make gains on its peers.
Article / 21 July 2016 at 8:42 GMT

FX Update: JPY drops on stimulus talk, ECB on tap

Head of FX Strategy / Saxo Bank
  • Yen drops on reports that Abe government may increase size of stimulus package 
  • NZD weaker as Reserve Bank of NZ talks up prospects for a rate cut in August 
  • ECB on tap today, but market isn't expecting any dramatic moves

Complacency reigns in the market ahead of today's ECB announcement. Pic: iStock

By John J Hardy

Japanese media reports suggest that the Abe government may be looking to increase the size of a coming fiscal stimulus package to some ¥20 trillion (around 4% of GDP). There were plenty of specifics in the source reports, including the percentages for various infrastructure projects versus credit to companies via the Japan Bank for International Cooperation. 

As most of the potential for stimulus for now is from the fiscal side in Japan, and the Bank of Japan’s current level of bond purchases easily covers the existing deficits and an expanded deficit in the event of a new stimulus, we have the potential for the BoJ to under-deliver next week. Another factor that is difficult to disentangle from BoJ expectations is the very strong recent risk appetite that is traditionally JPY negative. 

The Reserve Bank of New Zealand managed to clear the bar for a dovish surprise overnight, as it talked up the prospect for coming rate cuts and lowered the market’s expectations for the policy rate. The New Zealand two-year rate dropped some five basis points overnight, after dropping about 15 basis points just over the last week and over 75 basis points from the beginning of the year. There’s more to squeeze out of that trend as well if the RBNZ eventually cuts to 1.50% or lower by mid next-year – the market is only pricing in a bit more than 50 basis points of easing over that time frame. The overnight action has NZDUSD pushing on the 0.7000/0.6950 pivot area. The action lower has been very steep there lately, and bears risk a consolidation if the pair can’t continue to punch lower after this key event risk.

The European Central Bank is on tap later amid general expectations for some noise on further policy moves, but an assessment that the most likely grab bag of measures will have little market impact. The complacency is what stands out the most, so the ECB taking a different approach or announcing something unanticipated could make quite an impression on a market that seems asleep at the wheel. 

The most dramatic (if unlikely) move would be one to drop the capital key that requires buying bonds in proportion to each EU country's relative GDP size. This would allow the ECB to favour peripheral bonds, the argument being that they want policy transmission to be equally forceful across the EU.

Sterling has managed to pull higher after yesterday’s Bank of England monthly agents’ assessment, and as the first exchange with German Chancellor Merkel was more than civil. Today, May will meet with French president Hollande.

NZDUSD is flirting with the key 0.7000/0.6950 zone that has structural/trend implications if taken out here.

NZDUSD chart
 Source: Saxo Bank

The G-10 rundown

USD – most of the USD strength is limited to USDJPY and USD vs. AUD and NZD, and driven less by USD-related drivers. The action looks too passive considering the strong comeback in Fed rate hike expectations, and if the USD is going to prove itself, it needs to do so today versus the Euro in particular.

EUR – not sure what is driving EURUSD stronger from yesterday’s lows, as the US dollar continues to recover amid higher Fed rate hike expectations. Seems the market is expecting very little from the ECB, which means the bar is low for a dovish surprise.

JPY – seems we might be nearing peak stimulus expectations here, meaning we might need an ongoing melt-up in risk appetite to continue to see the JPY weaker from here.

GBP – sterling recovery looks solid and, from a positioning perspective, could have much farther to run – especially in EURGBP if the ECB manages to engineer a lower euro today. Key pivot area in GBPUSD is around 1.3300/25.

CHF – waiting to see whether the ECB meeting has implications for EURCHF – otherwise, the 1.08-1.0950 limbo makes it tough to take a view. A lifting of the uncertainty over Italian banks is likely key for engineering franc weakness.

AUD – rally in AUDNZD overnight on the dovish RBNZ is keeping AUD range-bound elsewhere, though we prefer it lower versus the USD, with the next key test at the 0.7300 area for bigger trend implications.

CAD – USDCAD is biding time within the range, though we expect an upside resolution.

NZD – weakness after the RBNZ’s economic assessment and pricing the virtual certainty of a rate cut at the early August meeting, and likely in November as well. The key 0.7000/0.6950 zone in NZDUSD is in play.

SEK – SEK remains unpopular, but could a more-dovish-than-expected ECB surprise and boost SEK here?

NOK – EURNOK offering few clues – watching for ECB reaction and oil prices.

Upcoming Economic Calendar Highlights (all times GMT)

  • UK Jun. Retail Sales (0830) 
  • ECB Announcement (1145) 
  • ECB’s President Draghi Holds Press Conference (1230) 
  • US Weekly Initial Jobless Claims (1230) 
  • US Jul. Philadelphia Fed Survey (1230) 
  • US Jun. Existing Home Sales (1400) 

  – Edited by D. Deacon
John J Hardy is head of FX strategy at Saxo Bank


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