Jumping at Shadows

Did the BOJ
Change policy? Or are we
Jumping at shadows?

While the dollar continues to perform well overall, rallying against nine of its G10 counterparts, the story overnight was about the tenth, the Japanese yen. The BOJ announced that they were reducing the amount of long-dated JGB’s they were purchasing by ¥10 billion (~$90B) leading to a rise in yields and correspondingly a rise in the yen. When the news hit the tape, USDJPY fell 0.5% within minutes, and despite an attempt to recoup those losses early in the European session, remains lower by 0.4% as I type. The sharp response is due to the idea that this is a significant policy signal although most analysts in Tokyo don’t believe that to be the case. Rather, it appears to be a reaction by the BOJ markets group to the reality on the ground, namely they don’t need to purchase as many bonds to achieve their targets. And actually, that is a key part of the discussion. The likelihood that the financial markets department would announce a change in policy rather than the full board is extremely remote. But it does feel like a harbinger of the future with regard to the yen. At some point the BOJ is going to start to remove policy accommodation and when they do so, it seems reasonable to expect the yen could rally pretty sharply. Of course, Japanese inflation levels remain well below their targets and so actual policy change from the top seems likely to still be far in the future. Meanwhile, the yen is likely to come under further scrutiny by both speculators and investors, which implies to me that underlying volatility in the currency could rise. Hedgers beware!

But away from the yen, the dollar continues its recent rally, rising another 0.35% against the euro and 0.55% against the Swiss franc. Once again, this movement takes place against a backdrop of solid Eurozone data although the Swiss story is a bit less positive. From the latter, we saw Swiss Unemployment rise to a more than expected 3.2% in December, while Real Retail Sales continued their recent decline, falling 0.2%. I guess neither of those things would be considered a Swiss positive. On the other hand, from Europe we continue to see solid data, with German IP rising a more than expected 3.4% and its Trade Balance expanding more rapidly than forecast as well, up €23.7 billion in November. Meanwhile, the Eurozone Unemployment rate fell to its lowest level, 8.7%, since January 2009. And yet, the euro continues its recent decline. Cumulatively, the euro is now lower on the year by about 1.4%, and while market technicians are not yet likely to jump on this bandwagon, and the prevailing narrative remains that the dollar will fall all year long, it still feels to me like the dollar has further room to run in this rally. After all, 10-year yields on US Treasuries have traded back to 2.50% for the first time since last March, and I remain confident that they will continue higher. Interestingly, yesterday’s only US data print, Consumer Credit, blew away estimates and grew by $28B, far more than the $18B expected, as consumers attacked their holiday spending with credit cards and revolving debt. Confidence certainly remains high in the US, yet another reason I find it difficult to accept the narrative of a lower USD this year.

Pivoting to the Emerging markets, the big story was out of China, where the PBOC removed the fudge counter cyclical factor from the calculation of the daily fixing leading to a 0.4% rally. Last year, if you recall, the PBOC introduced this feature as they were fighting ongoing weakness in the yuan amid significant capital outflows. To their credit, the combination of cracking down on capital outflows and adding in a non-market factor to the fixing equation was successful in stemming the decline. In fact, the yuan rallied a solid 6.6% last year. And I guess that was enough because going forward, they claim that the market will be the driving force again. And while I am sure that will be true for the short term, it remains abundantly clear that they will do whatever they deem necessary to achieve the FX level they want. So if CNY starts to move more aggressively in either direction, you can be sure the PBOC will add some new policy to prevent ‘excessive’ movement. Once again, I would question how the IMF could consider the CNY a market driven currency and eligible to be part of the SDR. Talk about politics!

As to the rest of the EMG space, the dollar is today’s big winner virtually across the board, with only ZAR showing any strength. The story here was a market rumor that President Jacob Zuma had resigned, although there is no substantiation of that fact. However, there is no doubt in my mind that if he did do so, the rand would see significant gains.

The only data point this morning is the JOLTS Job Openings number (exp 6.025M), which seems unlikely to drive the FX market. We also hear from uber-dove Neel Kashkari, so look for more discussion on why interest rates should never be raised again. He will certainly be happy to have heard one of the newer members, Atlanta’s Raphael Bostic, say yesterday, “…I would caution that that [removal of policy accommodation] doesn’t necessarily mean as many as three or four moves per year.” So there is another dove on the board. The thing is, if inflation does continue to tick higher, and we will learn more on Friday, even the doves will come around. So far nothing we have seen this year has changed my view that higher inflation and higher interest rates in the US are on their way, and a higher dollar alongside. As to today, I see no reason for this modest dollar rally to end, so would look for the euro to test 1.1900 by the end of the day as a proxy for a tad more dollar strength.

Good luck