Forty trillion yen
Kishida’s opening move?
Or his legacy?
While it has been quite a week in the FX markets, and in truth, markets in general, it appears that both traders and investors are now tired and price volatility has ebbed. While inflation remains topic #1 in most discussions, that poor horse has been beaten into submission at this point. We already know that it is running hotter than most forecasts and that its composition is broadening. This means the idea that Covid related issues, like used car prices or lumber prices, which have spiked (and in the case of lumber receded somewhat) due to supply chain issues is clearly no longer the only factor. In fact, wages are beginning to rise substantially and with higher commodity prices, input costs continue to climb (see PPI) which is rapidly feeding into retail costs. And it doesn’t appear this is set to slow anytime soon, despite the wishful comments by every central banker and finance minister around. So, what’s a country to do?
Well, if you’re Japan, this is the perfect time to…spend more money! And so, last night it was reported that new PM, Fumio Kishida, will be proposing a ¥40 trillion stimulus package in order to help support growth. The rationale is that GDP is forecast to have contracted in Q3, rather than following in the footsteps of other major nations which all saw varying levels of growth. Meanwhile, this being Japan, the home of the permanent deflationary impulse, one ought not be surprised at the fact that the BOJ and the government completely dismiss the recent PPI data (8.0% in October, a full point above expectations) as transitory given the decision that this will shore up the government’s approval rating. And anyway, all the forecasts point to a still subdued 0.1% Y/Y CPI reading next week so there should be nothing to worry about. After all, economic forecasts for inflation have been spot on around the world lately!
Since the last week of September, when USDJPY broke out of a six-month long trading range, the yen has fallen nearly 5%. I believe that the BOJ is extremely encouraging of this movement as it has been a tacit policy goal since the initiation of Abenomimcs in 2012, when the BOJ really went all-in on its QE initiative in an effort to defeat deflation. One thing for the Japanese to consider, though, is that history shows getting a little inflation is a very hard thing to do. Once that genie is out of the bottle, it tends to be far more unruly than anticipated. For Japan’s sake, I certainly hope that the PPI data is the outlier, but the risk of a policy mistake seems to be growing. And after all, central bank policy mistakes are all the rage now (see Federal Reserve), so perhaps Kuroda-san just wants to feel like a member of the club. At any rate, this morning the yen appears to be readying for the next leg lower and I would not be surprised at a move toward 116.75 before it’s all over.
But truthfully, there is not much to tell beyond that. As mentioned, there is still a lot of discussion regarding inflation and its various causes and effects. One thing to keep in mind is that history has shown the currencies of nations with high inflation tend to fall over time. And this does not have to be hyperinflation, merely inflation running hotter than its peers. Consider Italy, pre euro, where inflation averaged 5.4% and the currency regularly depreciated to offset the growth in prices. In fact, the entire economic model was based on a depreciating currency to maintain the country’s industrial competitiveness. The same can be seen in Turkey today, where each higher than expected CPI print leads to further lira weakness.
The point is, while Japan may not be able to create inflation, it is abundantly clear that we have done so in the US. And when push comes to shove, if/when the Fed has to implement policy to support financial stability, they will be faced with the “impossible trinity” where of the three markets in question, stocks, bonds and the dollar, they will support the first two and allow the dollar as the outlet valve. This means that eventually, a much weaker dollar is likely on the cards, not in the next several months, but very possibly within the next 2 years. For payables hedgers, especially with the dollar showing short term strength, it may be an excellent time to consider longer term protection. USD puts are very cheap these days. Let’s talk.
Ok, so what do I mean by dull markets? Well, equities are mostly higher, but generally not by very much. In Asia, the Nikkei (+1.1%) was the big winner on the stimulus news, but both the Hang Seng (+0.3%) and Shanghai (+0.2%) were only modestly better on the night. In Europe too, the movement has been relatively modest with the UK (FTSE 100 -0.4%) even falling on the day although the other major markets (DAX +0.1%, CAC +0.4%) are a bit firmer. US futures are also pointing higher, with gains on the order of 0.2% across the board.
Bond markets are mixed as Treasuries (+2.2bps) are softer after yesterday’s holiday, but European sovereigns are all seeing modest yield declines (Bunds -0.9bps, OATs -0.6bps, Gilts -0.9bps). That said, the peripheral markets also selling off a bit with Italian BTPs (+2.8bps) and Greek GGBs (+3.1bps) leading the way lower.
Commodities are actually the one market where there is still some real volatility as oil (-2.1%) leads the way lower alongside NatGas (-2.8%), although there is weakness in gold (-0.6%) and copper (-0.4%), all of which have had strong weeks. Frankly, this feels like some position closing after a positive outcome rather than the beginning of a new trend. In fact, if anything, what we have seen this week is commodity prices breaking out of consolidations and starting higher again. Agriculturals are little changed and the other industrial metals like Al (+1.1
%) and Sn (+0.6%) are actually a bit better bid. In other words, there doesn’t appear to be a cogent theme today.
As to the dollar, mixed is the best adjective today. In the G10, we have several gainers led by the pound (+0.2%) as well as several laggards led by SEK (-0.4%). The thing is, there is very little to hang your hat on with respect to stories driving the activity. Neither nation published any data and there haven’t been any comments of note either. In the EMG space, PHP (+0.6%) is the leading gainer on the strength of equity market inflows as well as central bank comments indicating they will seek to allow the market to determine the exchange rate. On the downside, RUB (-1.0%) is falling sharply on the back of oil’s sell-off and rising geopolitical tensions with Russia complaining about NATO activity near its borders. Between those two extremes, however, the movement is limited and pretty equal on both sides in terms of the number of currencies rising or falling. Last night, Banxico raised rates by 25bps, as widely expected and the peso is weaker this morning by -0.25% alongside oil’s decline.
Data-wise, JOLTS Jobs (exp 10.3M) and Michigan Sentiment (72.5) are both 10:00 numbers, but neither seems likely to move markets. NY Fed president Williams speaks at noon, so perhaps there will be something there, but I doubt that too.
For now, the dollar’s trend is clearly higher in the short term, especially if we continue to see Treasury yields climb. However, as mentioned above, I think the medium-term story can be far more negative for the greenback, so consider that as you plan your hedging for 2022 and beyond.
Good luck, good weekend and stay safe