The Yen Bounces after 13-Day Slide and BOJ Defends Yield Cap

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Marc Chandler
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Overview: The record-long yen slide has stalled just shy of JPY129.50, even though the Bank of Japan defended its Yield-Curve Control cap on the 10-year bond and will continue to do so for the next four sessions. The greenback fell to almost JPY128 before steadying. China again defied expectations for lower rates (loan prime rate), the yuan’s sell-off accelerated and slide to its lowest level since last October. Chinese and Hong Kong shares fell, but most of the other large markets Asia Pacific advanced. The Stoxx 600 is firmer in Europe, but US futures are off 0.5%-1.0%. The Swedish krona and Australian dollar lead the major currencies, all of which are stronger against the greenback through the European morning. Central European currencies may be aided by the euro, but other emerging market currencies are heavier today. The US 10-year yield is off six basis points to around 2.88%. European yields are also 5-8 bp lower. Gold was sold to a seven-day low near $1940 before recovering, and June WTI is consolidating in the $102-$103.65 area after being turned back from approaching $110 earlier this week. US and European natgas are diverging. US natgas is off for a second session after falling 8.25% yesterday, it is at a four-day low. Europe’s benchmark is up 2.3% today after yesterday’s 7.75% gain to trade at a five-day high.  Iron ore is steady after falling almost 5% yesterday. Copper is lower. It fell yesterday to snap a four-day advance. July wheat is steady.

Asia Pacific

After last week’s decision to keep the benchmark 1-year Medium-Term Lending Facility rate unchanged, the odds of a cut in the loan prime rate today fell. However, some thought it was still likely, and were disappointed by today’s decision to keep the one-year and five-year rates steady (3.7% and 4.6%, respectively). Chinese officials seem to be continuing to struggle of how and when to support the economy. The nearly two dozen measures announced yesterday were largely micro measures to ease the pressure on households and small businesses.  More is going to be needed.  In the meantime, as we anticipated, a weaker exchange rate, is also a shock absorber that could be used with little pushback given the broad greenback gains. The yuan’s two-day drop of about 0.7% may not sound like much, but it is the largest two-day decline since last June.

There continues to be lots of talk about challenges to the role of the dollar and diversification of reserves. Japan, with the second largest holdings of reserves, has an opportunity. The one-way market in dollar-yen, 13-sessions coming into today, is not healthy, and Japanese officials have repeatedly expressed concern about the pace of the move. If Japanese officials wanted to reduce their dollar holdings, reduce their reserves, which had been built up in the 1980s and 1990s through intervention, isn’t this an ideal time? The dollar is trading around 30-year highs against the yen. The dollar has risen almost 12% against the yen this year already. Central banks, it has been said, are long-term counter-trend speculators.  Central banks accumulate dollar assets when the dollar is weak not strong.

This is not to suggest actual material intervention is likely. Officials would take a few more steps up the intervention escalation ladder, such as shifting the focus from the pace to the level. They would also likely ratchet up the rhetoric to talk about “disorderly markets” and “excess volatility”. These are the conditions under which intervention can be justified. The relative strength of the yen over time has forced many industries in Japan to restructure their business to operate in a reasonably strong yen world. The yen is the most under-valued in more than 30 years against the dollar, according to the OECD’s measure of purchasing power parity (-33.2%). If the yen’s weakness is sustained, another major adjustment will prove necessary over time.

Japan still runs a current account surplus; it is just not driven by the trade balance. In fact, Japan reported a larger than expected March trade deficit earlier today. The JPY412 bln shortfall reflected slower exports and stronger imports. Although the JPY130 area is now widely recognized as the next important chart point, we suspect that it is no line-in-the-sand for Japanese officials. The argument in some circles that the BOJ’s cap on the 10-year yield is weighing on the yen is refuted, or at least challenged, by today’s developments. The BOJ offered to buy an unlimited amount of 10-year bonds at 0.25% today and indicated it would stand ready to do so over the next four-sessions. The yen recovered as some late shorts covered. This would seem to suggest that if the BOJ were to abandon its yield curve control, after an initial adjustment period, the yen could weaken again. One key seems to be the cost of hedging and setting the currency hedge ratios. Another consideration is the appetite from non-currency hedged exposure.

The proximity of the JPY130 psychological level may have made dollar bulls a bit nervous and eager to lock in some profits. The dollar fell to almost JPY128 before bouncing, but the rally fizzled near JPY128.75. It still looks vulnerable and a break of JPY127.75 would signal the next leg down. We suspect there may be potential toward JPY126.75. After testing the $0.7345 area in the past two sessions, the Australian dollar caught a bid and jumped to the $0.7430 area today. Our initial target is the $0.7465 area, which corresponds to the 20-day moving average and the (38.2%) retracement of the drop since the April 5 high near $0.7660. The dollar gapped higher against the Chinese yuan and traded to almost CNY6.42. It is above the 200-day moving average (~CNY6.4035) for the first time since last August. In our weekly note, we suggested a move above CNY6.40 could spur a move into the CNY6.50-CNY6.60 area. Although the PBOC had appeared to shy away from using the daily fix to guide the market, it came back today. The wide gap between the reference rate (CNY6.3996) and the median projection in the Bloomberg survey (CNY6.3895) was seen as a signal to sell the yuan.

Europe

UK Prime Minister Johnson’s apology yesterday was carefully worded to avoid acknowledging that he knowingly misled Parliament, which likely would have added pressure for his resignation. In any event, there will be a vote tomorrow to turn the issue over to a committee on Parliament standards. With an 80-seat majority, Johnson does not have to worry about losing the vote. Still, the defection of some Tories may capture the attention of the media. The police investigation is not over, and reports suggest the Prime Minister may be subject to additional fines. The key now is the May 5 local elections. A poor showing by the Tories, which seems likely, may raise questions about Johnson’s ability to lead the party to victory in 2024.

In France, Macron and Le Pen are in a nationally televised debate tonight. Both know how to play to the audience. The latest polls suggest Macron’s lead has widened in recent days. While France has a strong presidential system, the parliamentary election in June may ultimately shape the next presidency. Meanwhile, reports suggest France has offered a security guarantee for Ukraine, but Kyiv cannot count on it yet. France is a NATO member. For it to extend a security guarantee to Ukraine is a backdoor into NATO, without the formalities. It will likely be seen that way in Washington and Moscow. It will not help end the war.

Since early last year, there has been a dramatic deterioration of the eurozone’s trade balance. Consider that it recorded an average monthly trade surplus of 18.6 bln euros in 2019 and 19.5 bln euros in 2020. In the last six months of 2021, the average monthly surplus fell to 1.7 bln euros. Earlier today it reported a 9.4 bln euro deficit for February, its fifth consecutive shortfall. The six-month average stands at a 4.6 bln euro deficit and almost a 9.7 bln euro deficit average over the past three months. The surge in energy prices is the main culprit.

The euro is bouncing today after successfully testing the ECB-induced low from last week (~$1.0760). It is at a four-day high in Europe, having approached $1.0845.  Initial resistance may be in the $1.0860 area now, but the high from last week’s ECB meeting near $1.0925 may be more important. The failure to hold above $1.08 negates the constructive price action. Sterling settled below $1.30 yesterday for the first time since November 2020. However, there has been no follow-through selling today and the sterling briefly traded above yesterday’s high (~$1.3040). Still, it needs to resurface above $1.3065 to lift the tone.

America

The resilience reported yesterday of US housing starts and permits in the face of rising interest rates appeared to help lift US equities, and the rally appeared to have been led by other interest-rate sensitive sectors. Today’s attention remains focused on the housing market.  First, mortgage applications, which have fallen for five consecutive weeks through April 8, will be reported. Falling mortgage applications and reports of slower foot-traffic warn of some deterioration, as one would expect, and may indeed be taking place below the surface. The US also reports March existing home sales. The median forecast (Bloomberg survey) looks for a 4.1% decline after a nearly 7.25% fall in February. Existing home sales rose almost 6.6% in January after a roughly 3.8% decline in December.

The Federal Reserve, which does not meet until May 4 is also front and center today. At least three Fed officials speak today (Daly, Evans, and Bostic), and the Beige Book will be released later today. Powell is speaking on an IMF panel tomorrow with the ECB’s Lagarde. The market understood the signal by Fed officials and has fully discounted a 50 bp hike in May and is nearly there for June as well. Note that the Atlanta Fed’s Q1 GDP tracker was lifted to 1.3% yesterday from 1.1% previously. The US publishes its first estimate of Q1 GDP next week (April 28) and the median forecast (Bloomberg survey) is for 1% growth.

Canada reports March CPI today. The headline is expected to have accelerated to above 6% from 5.7% in February. The central bank’s underlying measures also likely accelerated.  Last November, the average of the three underlying measures was 2.86%. It has steadily rise to 3.47% in February. Earlier this month, the Bank of Canada become the first G7 country to hike by 50 bp. The swaps market has a strong leaning of another 50 bp move when it meets next on June 1.

For the better part of two weeks, the US dollar has been consolidating in choppy fashion against the Canadian dollar, mostly in a CAD1.2550-CAD1.2650 range. It is threatening to breakout to the downside today. Initial support may be seen in the CAD1.2520-CAD1.2540 band, but better support is around CAD1.2500.  Still, the move from yesterday’s high, the upper end of the range to the lower end of the range today, is stretching the short-term momentum indicators. The takeaway is to be careful about chasing the greenback lower now. The US dollar posted an outside up day against the Mexican peso yesterday by trading on both sides of Monday’s range and closing above Monday’s high. However, rather than signal a breakout, the price action, including the lack of follow-through dollar buying today suggests the broad consolidation seen this month is continuing. Look for initial support near MXN19.90, though the bottom of the range is closer to MXN19.75.

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