GBP
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In March the BoE hiked rates by 25bsp as expected but delivered a bearish hike with BoE’s Cunliffe dissenting by voting to leave rates unchanged. This was a stark change from February where 4 members voted for a 50bsp hike. Cunliffe noted the negative impacts of higher commodity prices on real household incomes and economic activity as the main reason for his dissention, while remaining members thought a 25bsp hike was appropriate given the tight labour market and risks of second round effects. Even though inflation forecasts were upgraded to 8% in Q2 (previous 7.25%), the negative view that GDP was expected to slow to subdued rates showed growing concern of stagflation. The most bearish element of the statement was a change in language regarding incoming rates where the bank said they judge that some further modest tightening MIGHT be appropriate where previous guidance said more tightening was ‘LIKELY TO BE’ appropriate (a clear push against overly aggressive rate expectations). They further pushed back by noting the current implied rate path would see inflation would be below target in 3 years’ time, in other words saying they won’t hike as much, and confirms our estimates that policy reached peak hawkishness in February. The 100% odds of a 25bsp in May drifted to just above 80% on Friday, and markets will pay close attention to incoming BoE speak, where further push back against rates could be enough to see markets pricing out some of the >5 hikes still priced for 2022. As a result of the clear dovish tilt, we have adjusted our assessment of the bank’s policy stance to NEUTRAL.
2. Economic & Health Developments
With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces stagflation risk, as price pressures stay sticky while growth decelerates. That also means that current market expectations for rates continues to look way too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.
3. Political Developments
Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
4. CFTC Analysis
CFTC data for Sterling is very interesting with growing divergence between participant positioning as Large Specs and Asset Managers sit on sizeable (and growing) net shorts while Leveraged Funds continue to increase net longs. With fast money (Leveraged Funds) pushing higher and Asset Manager net-short reaching bottom 20 percentile levels (2007 used as base year) one of these two are on the wrong side.
5. The Week Ahead
Labour and CPI data will be the main data highlights for the UK this week. For inflation our same concerns as the March data print are in focus where a higher-than-expected print might not necessarily be seen as a positive. Usually, higher inflation should be a positive for the currency as it means more chances of higher interest rates. However, the bank has been clear that there is a trade-off between inflation and growth and has explained their reluctance to deliver on STIR expectations for much higher rates. Thus, higher rates would not necessarily lead to higher rate expectations but instead could be seen as a negative with stagflation risks in
view. For the labour print, it might be tricky to trade as the question will be on whether markets focus on real household incomes or second-round effects. The BoE has been very concerned with second-round effects which means higher-than-expected earnings ‘should’ increase inflation expectations which could be seen as a negative for Sterling as explained. However, if the focus is on real household incomes increasing as a result of much higher average earnings that could be seen as a positive. Recall that the main reason for Cunliffe’s dissent in March was due to inflation’s impact on real household incomes. That means labour data could be a tricky one to navigate for Sterling on Tuesday.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
No surprises from the BoJ at their March meeting. As usual, the BoJ continued their three decade long easy policy with Governor Kuroda dismissing any chances of starting to debate an exit from the current policy stance. The language and tone were very similar to their prior meeting where the bank remained committed to provide any additional easing if necessary and noted that the current geopolitical situation increases the risks and uncertainty for Japan’s economy. The bank did note that they expect inflation to rise to close to 2% in Q2 as a result of the recent upside in oil prices, but the governor did explain that recent fears of stagflation in places like Japan, EU and US are overdone. Furthermore, Governor Kuroda explained that rates in Japan will remain low and the rate differential between Japan and other major economies are expected to lead to a weaker currency and higher domestic price pressures in the months ahead.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite is jittery. Even though that doesn’t change our med-term bias for the JPY, it does means we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place. In this environment there could be mild upside risks for the JPY, but we should not look at the influence from yields in isolation and also weigh it up alongside underlying risk sentiment and price action in other safe havens.
4. CFTC Analysis
Another increase in net-shorts for Large Specs & Leveraged Funds while Asset Managers trimmed some shorts, but net shorts for all three participant categories remain in the bottom 20% of lows going back to 2008. Even though the JPY’s med-term outlook remains bearish , the recent downside in price and increased net-shorts increases odds of punchy mean reversion with equities, US10Y and oil in focus.
5. The Week Ahead
New Japan fiscal year, US yields and jawboning will be key focus points next week. After the big flush lower in the JPY in recent weeks, there is some question markets over how much part the Japanese fiscal year end played, and now that a new year has started whether that leads to some JPY repatriation. On the yield side, our med-term bias remains bearish on yields given the slowdown we’ve seen in growth data from the US, but with inflation expected to reach close to 9% the inflation story has been in the driver seat. That means, US CPI will be an important focus point for the JPY this week. After the big dip in the JPY, we’ve had numerous official chime in about the weakness, and even though they didn’t exactly push back against it, they’ve clearly taken notice. The bad attention does make any moves into the 130 for USDJPY both interesting and risky for bulls, so watching for further jawboning from Japanese officials will be on the radar as well. On the energy front, it’s important to keep in mind that Japan imports more than 90% of its energy consumption, and research from JP Morgan suggests that a WTI price of $150 could erode Japan’s current account surplus (which is one of the reasons the currency enjoys safe haven appeal), which means yields and oil remain very important drivers.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In March the BoE hiked rates by 25bsp as expected but delivered a bearish hike with BoE’s Cunliffe dissenting by voting to leave rates unchanged. This was a stark change from February where 4 members voted for a 50bsp hike. Cunliffe noted the negative impacts of higher commodity prices on real household incomes and economic activity as the main reason for his dissention, while remaining members thought a 25bsp hike was appropriate given the tight labour market and risks of second round effects. Even though inflation forecasts were upgraded to 8% in Q2 (previous 7.25%), the negative view that GDP was expected to slow to subdued rates showed growing concern of stagflation. The most bearish element of the statement was a change in language regarding incoming rates where the bank said they judge that some further modest tightening MIGHT be appropriate where previous guidance said more tightening was ‘LIKELY TO BE’ appropriate (a clear push against overly aggressive rate expectations). They further pushed back by noting the current implied rate path would see inflation would be below target in 3 years’ time, in other words saying they won’t hike as much, and confirms our estimates that policy reached peak hawkishness in February. The 100% odds of a 25bsp in May drifted to just above 80% on Friday, and markets will pay close attention to incoming BoE speak, where further push back against rates could be enough to see markets pricing out some of the >5 hikes still priced for 2022. As a result of the clear dovish tilt, we have adjusted our assessment of the bank’s policy stance to NEUTRAL.
2. Economic & Health Developments
With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces stagflation risk, as price pressures stay sticky while growth decelerates. That also means that current market expectations for rates continues to look way too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.
3. Political Developments
Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
4. CFTC Analysis
CFTC data for Sterling is very interesting with growing divergence between participant positioning as Large Specs and Asset Managers sit on sizeable (and growing) net shorts while Leveraged Funds continue to increase net longs. With fast money (Leveraged Funds) pushing higher and Asset Manager net-short reaching bottom 20 percentile levels (2007 used as base year) one of these two are on the wrong side.
5. The Week Ahead
Labour and CPI data will be the main data highlights for the UK this week. For inflation our same concerns as the March data print are in focus where a higher-than-expected print might not necessarily be seen as a positive. Usually, higher inflation should be a positive for the currency as it means more chances of higher interest rates. However, the bank has been clear that there is a trade-off between inflation and growth and has explained their reluctance to deliver on STIR expectations for much higher rates. Thus, higher rates would not necessarily lead to higher rate expectations but instead could be seen as a negative with stagflation risks in
view. For the labour print, it might be tricky to trade as the question will be on whether markets focus on real household incomes or second-round effects. The BoE has been very concerned with second-round effects which means higher-than-expected earnings ‘should’ increase inflation expectations which could be seen as a negative for Sterling as explained. However, if the focus is on real household incomes increasing as a result of much higher average earnings that could be seen as a positive. Recall that the main reason for Cunliffe’s dissent in March was due to inflation’s impact on real household incomes. That means labour data could be a tricky one to navigate for Sterling on Tuesday.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
No surprises from the BoJ at their March meeting. As usual, the BoJ continued their three decade long easy policy with Governor Kuroda dismissing any chances of starting to debate an exit from the current policy stance. The language and tone were very similar to their prior meeting where the bank remained committed to provide any additional easing if necessary and noted that the current geopolitical situation increases the risks and uncertainty for Japan’s economy. The bank did note that they expect inflation to rise to close to 2% in Q2 as a result of the recent upside in oil prices, but the governor did explain that recent fears of stagflation in places like Japan, EU and US are overdone. Furthermore, Governor Kuroda explained that rates in Japan will remain low and the rate differential between Japan and other major economies are expected to lead to a weaker currency and higher domestic price pressures in the months ahead.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite is jittery. Even though that doesn’t change our med-term bias for the JPY, it does means we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place. In this environment there could be mild upside risks for the JPY, but we should not look at the influence from yields in isolation and also weigh it up alongside underlying risk sentiment and price action in other safe havens.
4. CFTC Analysis
Another increase in net-shorts for Large Specs & Leveraged Funds while Asset Managers trimmed some shorts, but net shorts for all three participant categories remain in the bottom 20% of lows going back to 2008. Even though the JPY’s med-term outlook remains bearish , the recent downside in price and increased net-shorts increases odds of punchy mean reversion with equities, US10Y and oil in focus.
5. The Week Ahead
New Japan fiscal year, US yields and jawboning will be key focus points next week. After the big flush lower in the JPY in recent weeks, there is some question markets over how much part the Japanese fiscal year end played, and now that a new year has started whether that leads to some JPY repatriation. On the yield side, our med-term bias remains bearish on yields given the slowdown we’ve seen in growth data from the US, but with inflation expected to reach close to 9% the inflation story has been in the driver seat. That means, US CPI will be an important focus point for the JPY this week. After the big dip in the JPY, we’ve had numerous official chime in about the weakness, and even though they didn’t exactly push back against it, they’ve clearly taken notice. The bad attention does make any moves into the 130 for USDJPY both interesting and risky for bulls, so watching for further jawboning from Japanese officials will be on the radar as well. On the energy front, it’s important to keep in mind that Japan imports more than 90% of its energy consumption, and research from JP Morgan suggests that a WTI price of $150 could erode Japan’s current account surplus (which is one of the reasons the currency enjoys safe haven appeal), which means yields and oil remain very important drivers.
