Let’s consider fear
It’s not only for traders
Ueda-san blinked
I’m old enough to remember the time when the BOJ turned hawkish, raised their base rate by the most in 15 years and promised to keep going. As well, Ueda-san explained they would slowly reduce their presence in the JGB market. In fact, I’m willing to wager you remember that too. After all, that was the message the market gleaned from the BOJ policy meeting that ended on July 31st, just seven days ago. Since then, equity markets around the world have fallen dramatically, the yen rallied dramatically, bond yields declined dramatically, and risk was definitively reduced.
Narratives were being rewritten around the world and concerns over the strength of the US economy were raised. Remember the lackluster employment report and all the discussion of the Sahm Rule having been triggered which implied the US was already in a recession? The global fear was if the US fell into recession, it would drag the rest of the world with it, since for now, the US economy is the strongest one around.
Well, apparently, policymakers around the world decided that the recent market chaos was a bit too uncomfortable for their political masters. It is a fair question to ask whether it was the BOJ’s more hawkish actions or the FOMC’s less dovish actions which drove recent market gyrations. But last night, the BOJ is the one that blinked first. Deputy Governor Shinichi Uchida, speaking to local business leaders in northern Japan said the following [emphasis added]:
“I believe that the bank needs to maintain monetary easing with the current policy interest rate for the time being, with developments in financial and capital markets at home and abroad being extremely volatile. In contrast to the process of policy interest rate hikes in Europe and the United States, Japan’s economy is not in a situation where the bank may fall behind the curve if it does not raise the policy interest rate at a certain pace. Therefore, the bank will not raise its policy interest rate when financial and capital markets are unstable.”
And presto! Fear has receded dramatically with the removal of concerns of further tightening by the BOJ, at least anytime soon. The biggest response was by the yen (-1.9%), with the dollar now having retraced about 50% of its decline vs. the yen since the BOJ meeting as per the chart below. (You can see where USDJPY was at the time of the BOJ announcement on the chart.). So, is everything better in the world? Clearly not, but one of the drivers of recent volatility has been walked back. As I wrote back on Monday, no politician is willing to tolerate short-term pain for long-term gain, and this is simply further proof of that statement.
Source: tradingeconomics.com
As to the rest of the market complex, most other asset classes are also unwinding some of the recent fear driven moves. Looking at equities, yesterday’s rebound extended further throughout almost every market in Asia with Japan’s Nikkei (+1.1%) rebounding more than 3% from its early session lows and gains of more than 1% in virtually every market in the time zone. The lone outlier here was China’s CSI 300 which was essentially flat on the day. Throughout Europe, as well, we are seeing gains of 1% or more across the board led by the IBEX (+1.65%) and CAC (+1.6%). As to US futures, at this hour (6:45) they too are showing gains of 1% or more.
One of the key themes among certain analyst circles has been that the BOJ’s ongoing liquidity spigot, which was ostensibly turned off last week, was THE key driver of all markets globally. In fact, the conspiratorial view was that global monetary policy was highly coordinated and that the reason the Fed was able to maintain its current policy stance effectively was because the BOJ would knowingly maintain its ultra easy policy. Ostensibly, this allowed the Fed to be seen as fighting inflation, the key political issue in the US, while Japan was able to maintain that inflation was still not stably at their target despite their core rate having printed above the 2% target for the past 28 consecutive months. I am not a fan of conspiracy theories as somebody always talks, but the results that we have seen over the past several years certainly indicate that was possible.
The question going forward is, will the BOJ restart their policy tightening this year? Perhaps, the next coordinated steps will be the Fed’s first cut in September, and possibly November, followed by the BOJ getting back on the tightening path by December. But for now, it appears that the past week was far too much market excitement for policymakers to handle.
Turning to bond markets, yields around the world are rebounding with 10-year Treasury yields higher by 4bps this morning and European sovereign yields higher by between 6bps and 9bps. UK Gilt yields are also 4bps higher and overnight in Asia, Australia, New Zealand and other countries saw yields rebound as well. The only outlier here was Japan, with JGB yields unchanged. The armchair analysis is that bonds as havens are not nearly as critical today as they seemed to be on Monday and Tuesday. If the policy directive is the Fed cuts next, this process should be able to continue.
In the commodity markets, we are also seeing a reversal of the recent losses with oil (+1.75%) really bouncing sharply. Arguably, part of this move is concern over the anticipated Iranian attacks on Israel and whether that will spill over into a wider Middle East conflagration impacting supply. But part of this is likely just a trading response to the recent sharp declines seen. In the metals markets, gold (+0.5%) and silver (+1.0%) are bouncing although gold has been the best performer in this space throughout the past gyrations. Copper (-1.7%) though is still under pressure and indicating that economic activity is slowing.
Finally, the dollar is firmer this morning, at least based on the DXY, led by its strength vs. the yen and CHF (-1.3%). However, looking at other currencies, we see AUD (+0.8%), NOK (+1.35%), SEK (+1.0%) and even CAD (+0.4%) all stronger. As well, both MXN (+1.6%) and ZAR (+1.0%) are firmer as it appears that traders are feeling more confident their carry trade positions are going to work well again. It should be noted that CNY (-0.4%) has reversed course, lagging the yen move, but then it lagged the yen strengthening move very dramatically. Currencies remain the final outlet valve for economies as they adjust to changes in policy. As such, with this new narrative of the BOJ backing off and the Fed getting set to cut, I expect that volatility in this space is likely to settle down for the time being. We will need a new catalyst to get people trading, and it seems the next opportunity will be next week’s US CPI followed by the Jackson Hole Symposium at the end of the month. Perhaps, although the beginning of August was far more volatile than expected, we are about to settle back into the doldrums.
There is no first-tier data released today but we do see the EIA oil inventories where further drawdowns are expected. Yesterday’s API was fairly neutral, but right now, it seems that the story is the Middle East, not inventories. Interestingly, there are no Fed speakers on the calendar either, although as we have seen consistently, it seems likely that we will hear from at least one before the day is through.
Today is a relief rally based on what appears to be a slight change in the narrative. It seems the apocalypse of tighter Japanese monetary policy and still tight US monetary policy is to be avoided. If that is the case, then look for markets to return toward their pre-BOJ levels, at least for now. For the dollar writ large, I feel like we could see general underperformance although there are clearly still a few currencies that may weaken further, notably the yen.
Good luck
Adf
fxpoetry 