BOJ Offers Verbal Support, Extends the Yen’s Pullback

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Marc Chandler
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Overview:  The calls earlier this week for an emergency rate cut seemed to be a call for the Fed put, which, we argue is misunderstood. It is not about the stock market per se but financial stability, which did not seem threatened in the US. Japan is a different story, and the Bank of Japan offered a verbal put today, with an indication that it wants to maintain low (accommodative) rates. The markets reacted accordingly. The yen was sold (and dragged down the Swiss franc as well). The dollar-bloc currencies and Scandis are trading higher, while the euro and sterling are consolidating. The Mexican peso, which has been beaten down, is the stronger emerging market currency today, gaining about 1.8%. 

Equities are mostly higher. The Nikkei gained 1.2%, but Taiwan led the charge with a nearly 4% gain. Europe's Stoxx 600 is up more than 1%. It sustained it would be the largest gain since mid-June. The S&P futures are up 1% as well, while NASDAQ futures are posting a 1.3% gain. The recovery in equities is sapping the demand for fixed income, and benchmark 10-year yields are mostly 7-8 bp higher in Europe. The US 10-year yield that bottomed Monday near 3.66% is up four basis points today to 3.93%. The two-year yield is five basis points higher at 4.02%. It bottomed on Monday near 3.65%. Gold is trading firmer to approach $2400. September WTI is also trading firmer, slightly below $74. Yesterday's high was closer to $74.55. 

Asia Pacific

The deputy governor of the Bank of Japan provided the first official response to recent market developments today and said he thought that rates should be held steady for the time being. The market took this as a dovish sign and took sold the yen while buying Japanese equities. The Nikkei continued to recover for a second day, building on Tuesday's gains. Still, the technical damage to the Nikkei has been barely corrected. It entered but failed closed the gap created on Monday's sharply lower opening (that extended to 35880). Today's high was about 35850. There is a gap created last Friday (~37470-37737) which may be the next target. The 10-year yield, which peaked around 1.10% (in May, June, and July), tumbled to 0.75% on Monday before bouncing to 0.96% yesterday. It consolidated today. In Australia, the hawkish hold by the RBA had limited impact. Before the recent market turmoil, the futures market had about a 20% chance of a November rate hike. On Monday, it was fully discounted. Calmer markets and the RBA statement saw the odds trimmed to about 57%. The Australian dollar failed to sustain early upticks and posted its lowest settlement yesterday since April. China reported a smaller than expected July's trade surplus (~$84.65 bln vs $99 bln in June). Exports slowed to 7% year-over-year from 8.6% in dollar terms. Imports jumped by 7.2% after falling by 2.3% in June. In yuan terms, exports rose 6.5% (10.7% in June) and imports rose 6.6% (-0.6% in June). Also, China reported July reserve figures. The dollar fell against most other large reserve currencies and bonds rallied. The dollar value of China's reserves rose by about $34 bln to almost $3.26 trillion, which is the highest since the end of 2015. Of note, the PBOC refrained from new gold purchases from the third consecutive month. 

Market participants are debating the proximate cause of the unwind of yen carry trades. One camp says it the shift in BOJ policy, while the other attributes it to the drop in US yields and the prospect of a Fed rate cut. BOJ Deputy Governor Uchida recognized both. The rolling 30-day correlation between changes in the exchange rate and the 10-year US yield is near 0.56. The recent high (late June) was a little above 0.60. The three-month low set in the third week of July was near 0.30. The 30-day correlation of changes in the exchange rate and Japan’s two-year yield is near 0.20, having been negative in late July and early August. The high for the year was set in late June near 0.30. Since in early Asia Pacific trading yesterday, the dollar has held above JPY144. It reached JPY147.90 on Uchida's comments. Near-term corrective pressure may extend toward JPY149.50-JPY150. Despite the hawkish hold by the Reserve Bank of Australia, the Australian dollar seemed reluctant to respond. However, the stabilization of risk appetites saw the Aussie recover in North America to session highs slightly above $0.6540. Resistance near $0.6550 has been overcome today and the Aussie reached $0.6565, a seven-day high. The $0.6575-$0.6600 area is the next hurdle. China is such a powerful actor on the global stage, but in the foreign exchange market so what less so outside of seeking stability. In practice, we see the yuan as being buffeted by some of the same forces as the Japanese yen (e.g., funding currency for carry-trades). What this means is that the correlation between changes in the offshore yuan and yen is high--above 0.70 for both the past 30- and 60-days. Want to know what the yuan will do? The yen gives a valuable clue. The setback in the yen saw the offshore yuan slump to a three-day low. The dollar extended its gains to around CNH7.1930 (CNH7.0835 on Monday). Near-term risk may extend to CNH7.20 and CNH7.22. The PBOC set the dollar's reference rate at CNY7.1386 (CNY7.1318 yesterday). 

Europe

Following the nearly 4% rise in June German factory orders reported yesterday, industrial output rose 1.4% (-2.5% in May). Strength was seen in domestic orders, led by autos and metal fabrication jumped by 9.1%. Foreign orders edged up by 0.4% after falling 3.0% in May. Still, today's report, with the benefit of rounding, could see Q2 GDP revised from -0.1% to flat. On the other hand, Germany's exports fell by more than 3% for the second consecutive month. Imports were slightly stronger (0.3%) after falling 5.5% in May. The trade surplus narrowed to 20.4 bln euros from 25.3 bln. The median forecast in Bloomberg's survey sees Europe's largest economy expanding by 0.3% this quarter, which is accurate, would match the strongest pace since Q3 22. Separately, France's June trade deficit narrowed to about 6.1 bln euros from 7.7 bln in May. 

The euro was confined to about a third of a cent above $1.09 in North America yesterday. It remains roughly in that range so far today. Recall that between last Friday (US jobs report) and Monday, the euro rallied from about $1.0780 to $1.1010. That two-day range is nearly as big as monthly ranges this year (~2.15 cents to 2.85 cents). Some near-term consolidation seems warranted. The economic diaries are light, though geopolitical tensions in the Middle East run high. The immediate threat is an Iranian strike on Israel. It was contained in April, but the situation seems precarious at best. Sterling looks precarious. It is in about a 20-tick range on either side of $1.27. It extended its decline yesterday to reach its lowest level since early July, slightly below $1.2675. However, it has approached a support area marked by the (50%) retracement of last month's sterling rally (~$1.2670) and the 200-day moving average (~$1.2655). Sterling has not traded below the 200-day moving average since mid-May. A break now could signal a move toward $1.2615, the June low and $1.2585 (61.8% retracement target).

America

The US reports June consumer credit today, which is not typically a market mover, and Boston Fed President Collins may speak (no vote at the FOMC this year). There is no need for officials to push against market speculation of emergency rate cut in response to the slump in equities. Most observers seem to have pushed back against such idea. Despite the volatility, the threat to financial stability has not risen to the level that requires a policy response. Of course, there is a preference for gradual adjustments, but the risk of overreacting seems more dangerous than not responding. Investors seem to easily spot moral hazard when it actions involve others but may be less concerned when they have skin in the game. Meanwhile, with elevated consumer debt levels and signs of strain, and easing of labor market conditions, consumer credit has slowed. Consumer credit growth slowed to an average of $8.2 bln in the first five months of the year, down from $13.75 bln in the Jan-May period last year and a whopping average of $29.3 bln in the same period in 2022. Canada surprised yesterday with its first monthly goods trade surplus in four months (~C$640 mln). It appeared to have little market impact. Today sees the IVEY PMI and the summary of the recent Bank of Canada meeting. Mexico reported a 12.2% drop in auto production in July after a nearly 6% decline in June. Still, it is 2.7% above year ago levels. Auto exports fell 8.2% in July falling almost 5% in June. Tomorrow, Mexico reports July CPI ahead of the central bank decision late in the session. Economists in Bloomberg's survey project a 1% rise in the headline rate for a 5.5% year-over-year pace. It would be the fifth consecutive monthly increase after bottoming in February at 4.4%. The core rate is expected to rise by about 0.3%, which translates into a slightly more than 4% year-over-year pace. The year-over-year rate has not risen since January 2023. Nearly half of the economists in Bloomberg's survey expect a rate cut and the pricing in the swaps market is consistent with a small chance of a move. Given the peso decline nearly 10% decline since mid-July and the rise of headline inflation, we expect the central bank to wait another month to cut (September 26), which would ostensibly be after the cut by the Federal Reserve. 

The pullback in the yen and bounce in US equities seemed to underpin the dollar-bloc currencies and Scandis yesterday. The Canadian dollar fully participated. Its slightly more than 0.4% gain was the best since late May. The greenback settled below CAD1.38 for the first time since July 23. It has now given back about half of its gains since the July 11 low a touch below CAD1.36. The US dollar's losses were extended today to about CAD13.750. The next support area is seen around CAD1.3700-25. Meanwhile, the yen's pullback has lent has eased pressure on the Mexican peso continued today. The dollar settled above the upper Bollinger Band (~MXN19.4470) for the third consecutive session. The greenback has unwound yesterday's gains and returned to around MXN19.22. Yesterday's low was closer to MXN19.14. To be sure, there are other considerations in addition to the yen. There is the rate cut speculation and, with an Iranian strike seeming coming soon, the peso may also be seen as vulnerable, and many recall the reaction a similar but different situation this past April. The Brazilian real, where the central bank signaled it is ready to hike if necessary was the best performer among emerging market currencies yesterday, followed by Chile and Colombia.