JPY: Heading for BoJ intervention?
Monday, September 6, 2010
, Posted by Usman Ali Minhas at 9:45 AM
Market Outlook
= JPY: heading for BoJ intervention?
Resilience in high yield and commodity currencies took us by surprise as demand for risk staged an early September comeback and US payrolls proved better than feared. However, with the outlook for the US not ceasing to cloud over (services ISM, new manufacturing orders) but Washington mulling tax breaks, demand for AUD and NOK will stay sensitive to incoming US data and broader appetite for risk. The week ahead features central bank meetings at the BoJ, Bank of Canada and RBA. BoJ intervention may prove the only effective ammunition to reverse demand for the JPY, but may be delayed until after September 14. The emergence of cracks in the UK do not spell good news for GBP and confirmation of softening industrial activity next week could see sterling extend one of the worst starts to a month since January. We look for the BoE to stand pat on BR and APF target. Our special note this week discusses the outlook for the JPY and CHF.
Recap
- USD fell against most G10 currencies as risk appetite resurfaced in the lead up to Friday’s non-farm payroll numbers and major equity and commodity markets rallied strongly. GBP continued to lose ground and dropped against every G10 currency. Among the most watched currency pairs, after dropping initially during the week, EUR/USD rallied 1% to 1.2886. GBP/USD recovered to 1.5444 after slumping by 1.3% at one stage to 1.5327, finishing the week down 0.6%. JPY remained firm against USD (+0.9%), GBP and especially EUR against the backdrop of continuing speculation about possible policy intervention by the BoJ, possibly after the September 14 DPJ leadership challenge.
- UK economic indicators showed significant slowing of activity. While, on the one hand, PMI surveys for manufacturing, services and construction showed a synchronised slowing of activity, on the other hand, the housing market saw the first back-to-back drops in average prices (down 0.9% m/m after falling 0.5% on Nationwide’s index). In the US, the uncertain economic picture got even harder to interpret. The ISM manufacturing index rose from the previous month (56.3 vs 55.5). The most significant release of the weak, Aug non-farm payrolls, came in better than consensus (-54k), but enthusiasm was tempered by a softer non-manufacturing ISM (51.5 vs 54.3 last) and decline in new orders.
- All major bond markets fell as risk assets posted handsome gains. Benchmark 10-year government bond yields finished the week higher for the UK (+11bp), Germany (+22bp), Japan (12bp) and the US (18bp). The sharp rise may be a reversal from overbought conditions (prices) after yields hit new all-time lows in late August. The major swap curves ended steeper with the 2y/10y spread widening 10bp in the UK, 11bp in the US and 18bp in Germany. The GBP 3mth libor/OIS spread was unchanged at 23bp. The 2014 auction was covered 1.69 times (0.7bp tail). Thames Water issued £300mln of 2030 paper at 250bp over gilts. The FTSE rallied 5.3% to close over the 200d MA at 5,400.
G10 FX: JPY, CHF: where next?
A relentless squeeze in JPY and Swiss Franc has driven both currencies to overbought levels last seen at the end of 2009. With key BoJ and SNB meetings scheduled over the next two weeks, this begs the question if profit taking and a trend reversal in JPY and Franc vs G10 are imminent. The fact that recent BoJ and SNB rhetoric have not been successful in diminishing demand means that performance of other asset classes (equities and government bonds) may prove more influential near term, unless more radical intervention by the BoJ (unsterilised JPY selling) is considered.
Overbought conditions in the Franc and JPY have been evident since early July and are clearly visible on the chart ‘IMM Percentile Rank’ . This coincided with the distinct worsening of US macro data and jitters in global risk assets. However, corrections due to rallies in risk were successively met by fresh bids for JPY and CHF longs and resulted in a swift return to overbought conditions in August.
The BoJ last week expanded its monetary easing programme by adding Y10trln liquidity over 6 month maturities in a bid to slow JPY appreciation. Verbal intervention by Cabinet/MoF officials have supplemented BoJ efforts but has so far been ignored as USD/JPY has failed to take off. This has prompted more explicit intervention talk by DPJ leadership candidate and PM Kan challenger Ozawa. The leadership contest will be decided on September 14.
In contrast, the SNB has become more tolerant of Franc strength, allowing EUR/CHF to fall below 1.30 and USD/CHF to flirt with parity. The Bank admitted this week that it is not drawn to a particular level for the Franc, a statement that reaffirmed the language shift adopted at the previous policy meeting in June. Foreign currency reserves have been whittled down over the last two months from a peak of 238.8bln SwF in May to 221bln SwF in July. Though the implied futures strip bets on no SNB tightening before the middle of next year, we think a further decrease in reserves could be followed by an earlier rate hike. As the recovery of the economy proceeds apace and forecasts for 2010/11 GDP are upgraded at the September 16 board meeting, the latitude for a major Franc retracement does not appear compelling.
Based on the BoJ’s limited policy success, a positive real Japanese G10 yield spread (see bottom chart) and outperformance of Japanese 5y CDS vs the US and Germany (see other chart), a similar conclusion could be drawn for the JPY until the BoJ raises the intervention stakes. With USD/JPY still 5 cents away from the 1995 low, selling rallies in USD/JPY are likely to remain attractive as long as talk of additional QE by the Fed persists. Chances of the FOMC deploying QE2 on September 21 have fallen back after stronger than forecast August payrolls and ISM data, but with doubts still hanging over the recovery, further Treasury purchases cannot be ruled out. A widening in the 10y UST/JGB spread from the 149.5bp low towards 173bp should in theory add short-term upside to USD/ JPY, but conviction among JPY sellers at this stage is still low as post US payrolls price action demonstrates.
The question then is whether the tentative but perceptible change in sentiment vis-a-vis risk assets, observed since Bernanke’s August 27 testimony at Jackson Hole, could be the trigger for a unwinding of safe haven flows. We are not convinced and point to the rally in gold above $1,250 to argue that pockets of resistance against prorisk remain deep, though gains across other soft commodities and metals cannot be disregarded. With this in mind, we think BoJ intervention is inevitable.
