Is the Dramatic Yen Short Squeeze Over?

by
Marc Chandler
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Overview:  The powerful yen short squeeze that has roiled the capital market this week has stalled today. It is the first day this week that the dollar has not fallen below the previous day's low and has risen, though slightly, above previous session's high. The Antipodeans and Scandis are trading with a firmer bias. The yen and Swiss franc are the only two G10 currencies that are not stronger today. The stability of the yen appears to have removed some of the pressure on some emerging market currencies. The Mexican peso is still heaviest currency this week, but on the day, it is the best of the emerging market complex, with the South African rand slightly behind it. 

Modest losses in Tokyo extended the Topix loss this week to 5.6% and the Nikkei's decline to nearly 6%. Other large bourses in the region rose but Taiwan, which played catch-up after being shut due to a typhoon for the past two sessions. It dropped about 3.3% to bring the weekly loss to nearly 7%. Europe's Stoxx 600 fell around 1.35% in the past two sessions and is up about 0.5% in late European morning turnover. US index futures are trading firmer and the key to the recovery may be the gap created by Wednesday's sharply lower opening in the S&P 500 and NASDAQ. While China's 10-year bond yield fell to a new recover low below 2.18%, the yield of the 10-year JGB ticked up one basis points point to about 1.05%. European benchmark yields are mostly 1-2 bp higher, but the UK Gilt yield is flat to slightly softer. The same is true for the US 10-year yield. It is slightly below 4.24%, off a little less than two basis points this week. The two-year yield is flat at 4.43%, which leaves it almost nine basis points lower than a week ago. After falling to about $2253 yesterday, gold is consolidating today below $2380, leaving it off about 1.2% this week. September WTI posted a potential key reversal yesterday, but follow-through buying was limited to about $78.60 and is straddling $78 in Europe. 

Asia Pacific

One of the key developments that has roiled the capital markets has been the powerful short squeeze of the Japanese yen. It may have run its course. Today's report of Tokyo's July CPI is unlikely to change many minds about the outlook for the BOJ next week. The headline CPI slipped to 2.2% from 2.3%, while the core rate ticked up to 2.2% from 2.1%. That reflected higher energy prices. Without fresh food and energy, Japan's CPI slowed to 1.5% from 1.8%, the lowest since August 2022. The swaps market has about an 80% chance of a 10 bp BOJ hike next week, almost double what it was Monday, but only slightly higher than yesterday. 

After falling to its lowest level since early May (~JPY151.95), the dollar recovered to a new session high yesterday slightly above JPY154.30. It appears to have left a bullish hammer candlestick in its wake. This is a reversal pattern and is a yellow flag warning that the dramatic drop, or at least this leg of it, is over. Today is the first session this week, that the dollar has not fallen below the previous day's low (so far). It is also the first time this week, that the dollar has taken out the previous day’s high, albeit marginally, (~JPY154.45). Resistance is in the JPY155.00-50 area. The Australian dollar down draft extended to the ninth consecutive session yesterday. This has been the worst week of the year for the Aussie, which, with today's modest gains, is still off about 1.8%. Its recovery off the $0.6515 area stalled near $0.6560 but has risen a little further today. The offshore yuan, on the other hand, is having a solid week, despite the surprise rate cuts, and even with the 0.25% pullback today. The 0.35% appreciation is the most since early May. The unwinding of carry trades seems to help explain the yuan's gains, and also the Swiss franc, which is the only other G10 currency that gained on the dollar this week. The PBOC set the dollar's reference rate at CNY7.1270 (CNY7.1321 yesterday and CNY7.1315 a week ago). 

Europe

The ECB's survey found one- and three-year CPI expectations was steady at 2.8% and 2.3%, respectively in May. A market-based measure of inflation expectations looks at break-evens (the spread between the conventional yield and the inflation-protected security.). Germany's seven-year is the shortest maturity available and the breakeven fall to a new low for the year yesterday near 1.76% and slightly firmer today. Italy's two-year breakeven straddled the 1.3% area yesterday, the lowest in nearly three years. That said, the base effect warns that headline eurozone CPI likely ticked up this month as the 0.1% decline from July 2023 drops out of the 12-month comparison. Yet, the median projection in Bloomberg's survey sees a 0.2% decline to allow the year-over-year rate slip to 2.4% from 2.5%. The core rate may firm as well, and it has not fallen since April.

The euro rose a few hundredths of a cent above Wednesday's high yesterday near midday in North America and was greeted with strong selling that knocked it back to the middle of the day's range. Corrective forces still to be operative. It is in about a 10-tick range on either side of $1.0850 so far today. It has settled in a $1.0845-55 range since Monday. Sterling remained on the defensive. It was sold to two-week lows in the North American afternoon. It approached the 20-day moving average (~$1.2855) and the (50%) retracement of this month's rally (~$1.2830). The momentum indicators are still falling, but sterling has stabilized today in about a quarter-cent range above $1.2850. 

America

Today's US data, personal income, consumption, and deflators pose headline risk but will not contain new information. Yesterday's Q2 GDP contained the personal income and consumption data. Similarly, although the Fed targets the headline PCE deflator, it can be largely extrapolated from the CPI (and PPI) reports. Hence, the risk of a significant surprise is minimal at best. A 0.1% increase in the PCE deflator will allow the year-over-year rate to slip to 2.4% from 2.6%. Such an increase on the month translates into a 1.6% annualized rate after a pace in Q1 and a 2.0% in H2 23. A 0.2% rise in the core rate could see the year-over-year pace slow to 2.5% from 2.6%, depending on the rounding. A 0.2% rise puts the Q2 24 annualized pace around 2.1% after about a 4.4% annualized pace in Q1 24 and slightly less than 2% in H2 23. Yesterday's GDP (and durable goods orders) did not change Fed expectations materially. Despite the call from the former NY Fed President, the derivatives market sees little chance of a Fed cut next week, and it continues to have a minor risk that the first Fed cut in September is more than 25 bp. The Fed funds futures are discounting two cuts fully this year and nearly a 75% chance of a third cut. At the end of last week, the futures market had about a 45% chance of third cut. Mexico reports its June goods trade balance today. Mexico's trade deficit is about a third smaller this year through May from the year ago period. Recently, Mexico's finance minister has taken a tougher line toward its trade deficit with China. There was even the mention of the possible desirability of common tariff regime with the US and Canada. The USMCA will be officially reviewed in 2026, and this would appear to be very much to the liking of whoever occupies the White House as it would enhance the US influence and deter end-runs around US tariff barriers. 

The US dollar consolidated after making a marginal new high for the year against the Canadian dollar (~CAD1.3850). The upside momentum was not sustained but the greenback still settled above its upper Bollinger Band (~CAD1.3815) and above the trendline drawn off last November 's and April's highs. The US dollar has a seven-day advance coming into today and it has risen in 10 of the past 11 sessions. It is trading in a narrow range today of a little more than 15 ticks, mostly below CAD1.3825. The greenback's rally was also extended against the Mexican peso, yesterday. It reached almost MXN18.59 and stopped shy of the end-of-June higher closer to MXN18.60. It settled firmly and above Wednesday's high (~MXN18.43). The greenback is better offered today and is trading below MXN18.35 in the European morning. The upper Bollinger Band is near MXN18.52 today. The peso is the weakest emerging market currency this week, off about 1.55%, or nearly twice the loss of the second weakest emerging market currency, the Czech koruna. The powerful unwind of carry trades, where the peso was among the favorites, has taken a life on of its own but if the yen stabilizes, the peso may as well.