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The European Central Bank meets this afternoon in the wake of the Italian referendum and, despite the fallout not yet being of the magnitude that analysts had predicted, it looks likely that the central bank will calm a nervy market with an extension of its bond-buying programme.
Article / 04 October 2016 at 8:30 GMT

FX Update: USDJPY breaking higher

Head of FX Strategy / Saxo Bank
Denmark
  • BoJ allows for vastly expansion of fiscal stimulus without having to alter policy
  • Important technical JPY-levels are getting challenged this morning
  • NZD is one of our least favored currencies if rates continue higher

By John Hardy

Yesterday, FTAlphaville linked to
a blog post that in turn discussed another blog post (would that be a blog-chain?) discussing the longer term implications of the Bank of Japan’s new policy paradigm. The original post was written the day after the BoJ meeting on the longer term implications of what the shift to yield-curve targeting, rather than a monetary base expansion, entails. 

The posts echo the same point that we have been making, namely, that while the very near term implications from the BoJ shift are for the possibility of a de facto asset purchase taper, or far lower rate of JGB purchases because it might prove quite easy to keep Japanese yields near current levels, the longer term implication is that the BoJ has enabled the government to vastly expand fiscal stimulus without having to alter BoJ policy any further to accommodate that stimulus. This is a far quicker path to suppressing real rates and generating the financial repression necessary to deflate the real value of Japan’s public debt in the long haul.  

The posts above further make the useful point that, by more or less fixing bond yields at 0% for 10 year JGB's, the BoJ makes those JGBs almost a form of cash that the government can “print” to spend and allows a quicker expansion in the nominal economy – i.e., inflation, as opposed to the real economy. The other point made is that the BoJ effectively loses control of its balance sheet if it makes good on controlling the yield curve – whether because the holders of JGB’s decide to dump them onto the BoJ or because fiscal stimulus requires a faster purchase rate or both. While over the longer term, we can’t know when the Japanese government seizes the initiative and possibilities that the new framework provides, the situation is ripe with implications for ugly real returns in Japan down the road, which at minimum should keep a lid on the currency, and could eventually send it much weaker again.

Chart: USDJPY
This has been our most often displayed chart lately, and yesterday we mentioned that the near term side of least resistance may be higher due to the lack of follow through of JPY buying after the kneejerk reaction to the recent key BoJ/FOMC meetings. We’ve taken out the descending trendline in this morning’s trade, which is step one. Step two would be a takeout of the Ichimoku cloud, which has held well since broken at the tail end of 2015. A squeeze above the cloud could put the pair back into the 105-107.50- range.
 
The G-10 rundown

USD – The USD is firming broadly, led most importantly by USDJPY, where very important resistance is being challenged today. The driver may be higher US rates and the fact that Japanese rates are now more or less frozen.

EUR – The euro is drooping against the US dollar, even if middle of the pack relative to a struggling JPY and sterling. Yves Mersch, Member of the Executive Board of the European Central Bank, was out yesterday warning that further ECB rate cuts could backfire, suggesting that the ECB has already maxed out on both rate cuts and asset purchases. 
Once the market has repriced yen, could we see a switch to a more negative focus on the euro if the market smells a shift to a yield focus? (Such a focus from the ECB would be interesting, as they could both drastically taper their bond purchases but also crush yields lower at the periphery if they can jettison the capital key requirements to allow a greater allocation to peripheral bonds.) We’re probably way too early on this, but the ECB will also be forced into a policy shift soon.

JPY - Important technical levels are getting challenged this morning – the next ones are shown in the chart above. The medium to longer term question once we possibly run through some stops higher above 103.00/25 is the time frame of the switch to a fiscal focus, as a long delay until the arrival of fiscal stimulus could mean we merely have a floor on the JPY rather than a fresh weakening trend.

GBP – Sentiment on GBP continues to weaken as the UK economy’s crown jewel, financial services, seen threatened by the hard Brexit scenario. New lows in GBPUSD this morning not seen since the mid-1980’s with round figures the next focus if the action continues lower, starting with 1.2500.

CHF - CHF is modestly weaker versus the euro on the fading of the Deutsche Bank worries and as rates tick higher, leaving the lowest yielders like CHF high and dry.

AUD – There were no surprises coming from the RBA overnight as market not looking for much anyway. Given recent AUD firmness, the impulse was to sell the fact. Interesting for AUDUSD trades that we continue to turn away from the 0.7700/50 zone as we watch for downside confirmation that has not yet been forthcoming.

CAD – Energy prices are the lone support for CAD – important combination of US and Canadian data later this week possibly supporting our view of a move higher through 1.3250 resistance that held recently.

NZD – This is one of our least favored currencies if rates continue higher as this would challenge the reach-for-yield theme, and we have seen signs of NZD broadly turning weaker. Still, it wouldn’t hurt to see NZDUSD breaking down through 0.7200/25 after an absurdly long bout of indecision.

SEK – EURSEK once again is uncomfortable above 9.60 but neither have the sellers come in force as there is little to like about SEK apart from valuation, given its very negative yield. A reminder of the headwinds for longer term Swedish growth on Thursday as the average house price indicator presses toward SEK 3 million – from SEK 1.5 million in late 2005. The hangover of the credit binge in Sweden will be one for the ages.

NOK – A move stronger in NOK recently justified on Norges Bank switching into neutral and with the solid rally in oil prices, but we’re rapidly approaching fair value unless the commodity theme extends from here.

Upcoming Economic Calendar Highlights (all times GMT)
  • 0830 – UK Sep. Markit/CIPS Construction PMI 
  • 1050 – Euro Zone ECB’s Praet to Speak 
  • 1100 – Euro Zone ECB’s Knot to Speak 
  • 1205 – US Fed’s Lacker (FOMC non-voter) to Speak 
  • 2230 – Australia Sep. AiG Performance of Services Index 

— Edited by Clemens Bomsdorf


John J Hardy is head of FX strategy at Saxo Bank

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