Written by Convera’s Market Insights team
Yen tumbles after BoJ hike
George Vessey – Lead FX Strategist
In a historic shift from decades of massive monetary stimulus, the Bank of Japan (BoJ) ended eight years of negative interest rates. The yen weakened and Japanese government bond yields fell in a classic case of ‘buy the rumour, sell the fact.’
The BoJ raised its key short-term interest rate to around 0% to 0.1% from -0.1%, the first rate hike in Japan since 2007, as inflation had exceeded the central bank’s 2% target in over a year, while the largest companies in the country agreed the biggest wage hikes in 33 years. Meanwhile, the central bank also terminated yield curve control for 10-year government bonds, although in its policy statement, the bank said it will continue purchase at broadly the same amounts, which means the BoJ isn’t taking a hawkish stance.
With rates still stuck around zero, the yen remains a funding currency and is likely to keep being utilized for carry trades, hence it has weakened across the board with USD/JPY reclaiming the ¥150 handle whilst GBP/JPY is back above ¥191 – close to its highest level since 2015.
Dollar steady as Fed meeting looms
Boris Kovacevic – Global Macro Strategist
The US dollar index (DXY) held inched higher around the 103.80 mark as the yield on the US 10-year Treasury note was little changed around 4.3% to kick off the week. Investors are gearing up for the Federal Reserve’s (Fed) monetary policy decision on Wednesday, expecting interest rates to remain unchanged but eager for new economic projections and clues about the timing and scale of rate cuts this year.
Market pricing is now finally back in line with the FOMC’s own rates projections, published via the dot plot back in December, showing three rate cuts for 2024. The probability of the Fed even delivering less rate cuts than this base case has risen from zero to 35% since the beginning of February as the excessive easing bets have been pared back. With government bond yields rising in every single trading session last week against the backdrop of the inflation surprises, discussions have emerged about the upcoming dot plot this week showing only two rate cuts for the year. While not our base case, such a revision remains a threat for investors holding risk sensitive assets hoping for a quick pivot from the Fed. Still, we do think that the re-pricing of easing expectations is approaching a limit on the downside as the disinflation trend continues in the second quarter.
Our analysis shows that on Fed decision day, the USD tends to depreciate against its G10 peers. Although the DXY has climbed around 2% this year, as markets scale back their expectations of Fed policy easing, unless it reclaims the 105 threshold in the wake of a potentially hawkish Fed this week, we think the DXY’s peak for 2024 may already be behind us.
Sterling’s headwinds are growing
George Vessey – Lead FX Strategist
The pound is nursing a mild year-to-date loss versus the US dollar but is up over 1% against the euro as currency traders prepare for a slew of central bank decisions, including the Bank of England (BoE) this week. Less than three 25 basis point rate cuts are currently being priced in by markets for 2024, suggesting risks to sterling lean asymmetrically to the downside given inflation surprises tilting lower and softer labour market indicators of late.
Another major headwind for the pound is positioning. CFTC data on FX positioning showed the net GBP long (bets on GBP appreciating) rose for the 10th week out of the past 11 in the week ended March 12. These bullish bets are now at their highest level since 2007, which suggests sterling upside potential could be limited and the British currency could be more sensitive to softer data surprises going forward. Tomorrow, the latest UK inflation report is expected to show headline inflation fall to 3.5% from 4%, but all eyes are on services inflation – one of the BoE’s key indicators for determining the timing of the first rate cut. This currently stands at 6.5%, much higher than the Eurozone’s 4%. But it’s become clearer over recent months that the UK inflation story has simply been lagging that of the US and Eurozone, and momentum has slowed significantly over the past three months.
Should UK CPI hint at inflation falling faster than expected, we may see more BoE officials vote to cut interest rates this Thursday, weighing on sterling. But amidst the current period of low volatility and elevated risk appetite, sterling remains well supported given is status as a high beta currency.
Limited bullish euro potential ahead of FOMC
Ruta Prieskienyte – FX Strategist
Financial markets started the week cautiously, as multiple central banks will announce their decisions on monetary policy in the upcoming days. EUR/USD stumbled below its support level at $1.0880 (14-day SMA) as the investors trimmed Fed’s June rate cut bets but continued to trade uneventfully supported above by $1.0850 barrier.
As expected, the final Eurozone inflation rate release for February was confirmed at a 2.6% y/y (3-month low), showing disinflation is continuing in the euro area. Lower inflation is necessary, but not a sufficient condition for the European Central Bank to ease its policy rates from historic highs at 4%. The Governing Council is also laser-focused on wages to judge whether domestically generated cost pressure is abating in a sustainable way. If pay growth continues to moderate, as we expect it will, the first-rate cut is likely to happen in June. Interest-rate traders are positioning for a Q2 rate cut with 85bps of cuts by year-end, with 63.8% probability of a June rate cut.
What can we expect going into the day FOMC decision week? Over the past 14 meetings, the day ahead of the Fed decision, EUR/USD tended to close within 0.3% band of the day’s bid open with no statistically significant trend to support marginally bullish or bearish trend. With EUR/USD overnight ATM options not pricing in an increase in volatility either, we are expecting the euro to remain neutrally positioned against the US dollar, with investors hesitant to put on large last-minute positions. As a result, it is possible that markets will not react too much to today’s Eurozone wage growth report and German ZEW survey and wait until FOMC on Wednesday. Today’s target for EUR/USD is $1.0840 – $1.0900, but sentiment remains bearish.
Yen plunges 1.5% from last week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: March 18-22
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
