News & analysis


This morning’s Bank of Japan meeting rounds off a busy week in markets. The combination of localised political risk in emerging markets and France, lower US inflation counterbalanced by a hawkish Fed, and now disappointment from the BoJ has led 1-week realised volatility to rise across most major currency pairs. For reference, 1-week realised volatility in EURUSD now sits at its highest since early February, mid-April for GBPUSD, and since early May when the BoJ’s last intervened in markets for USDJPY. As mentioned, it was disappointing news from the Bank of Japan overnight that has maintained high levels of volatility, with the yen dropping close to seven-tenths of a percent against the dollar as the central bank maintained its stance on JGB purchases for now, instead committing to outline a “substantial” tapering plan at its next meeting in July. This was underwhelming for markets that had been bracing for an earlier decision on tapering after an abundance of “sources” stories in the past week and the signal that would have sent on the BoJ’s intentions for broader monetary normalisation. That said, while the yen trades under pressure this morning, we suspect it has little room to fall further as it enters intervention territory at the 158 handle.

While the past week has been busy for FX markets, it has also been highly informative. Traders have shown a clear hesitation to structurally short the dollar despite early signs of easing inflation pressures in the US, potentially reflecting the failed attempts to sell the dollar on the US disinflation narrative in mid-and-late 2023. The dollar’s defensive attributes are also likely to remain supportive over the summer months, limiting the extent to which it can depreciate. Political risk has been playing a primary role in this context in recent weeks, and is likely to continue doing so over the summer months as the US presidential election comes into focus. But the greenback is also likely to remain in favour as markets struggle to distinguish between soft and hard landings as the US economy deflates. The dollar bid yesterday as initial jobless claims spiked following a sudden stop in supercore inflation highlights exactly this. Although we don’t think something more sinister is afoot in the US, we continue to see a narrow path for the dollar to sell off on softer US data, with recession-fuelled pullbacks likely. Finally, with the Fed unlikely to move on rates before September, rate differentials are likely to remain supportive of the dollar over the summer months as well. All told, this leaves the dollar with little room to correct lower by our estimation, even as global inflation cools and growth measures improve.


The single currency was swept up in the deterioration in risk conditions yesterday, falling 0.66% on the day to completely reverse Wednesday’s post-CPI rally. French politics continued to play a role in the single currency’s decline, as the CAC 40 index fell 1.8% on the day as yield spreads blew out to their widest since 2017, even when factoring the initial Covid-induced widening back in 2020. External factors also played a role. Another unexpected spike in initial jobless claims soured overall risk sentiment as traders questioned whether the US economy is nosediving, especially after Wednesday’s data showed a significant decline in US core inflation pressures. Downside pressure remains evident in the euro this morning, with French equities and bonds once again underperforming regional indices. We are starting to become sceptical of how much further markets can price a political risk premium in French assets. After all, bond spreads are now at levels last seen when Le Pen was threatening Macron’s positioning at a presidential level, and running on the platform of Frexit, neither of which are the case now. Nevertheless, momentum in both markets and polls suggests not trying to catch this falling knife, not yet at least. However, we would warn against positioning short EURCHF on the French election risk at current levels. While we think the SNB will hold rates next week as activity and inflation momentum remains strong, we can’t categorically rule out a rate cut, especially as the franc now trades back at levels that prompted Swiss policymakers to cut back in March.


While yesterday’s Labour party manifesto launch could have posed a risk to sterling, ultimately it proved a non-event, delivering no new policy announcements to upset the narrative. Barring any surprises, this should now clear the path to election day and a significant Labour majority, an outcome that we have previously suggested is likely to be sterling supportive. We continue to think this is the case, though there is a growing risk to the pound stemming from a fracture of the right wing vote, especially given news overnight that the Reform party have overtaken the Conservatives according to the latest YouGov poll. This could potentially turn the election into a Conservative extinction event, leaving no effective opposition in parliament, an outcome that we struggle to see as positive for the pound in the long run. For now though, a Bank of England inflation expectations reading is the only notable event left this week, where another modest fall should do little to disrupt a quiet run into the weekend for sterling.


Thursday saw USDCAD continue to unwind its post-US CPI moves, with the pair now trading only a fraction off levels seen at the beginning of the week. In large part this is a product of markets continuing to digest Wednesday’s hawkish Fed messaging, but we would also note that BoC Governor Macklem has been hitting the airwaves in recent days too, striking a notably dovish tone. Granted, the Governor is playing his cards close to his chest, not pre-committing to any future policy moves. But unlike counterparts at the ECB for example, this leaves the option of back-to-back rate cuts on the table. In our view, this is justified by the data, which has proven notably weak of late. If realised, however, it would also leave the loonie looking rich at current valuations, a dynamic that should continue to support a slow grind higher for USDCAD in the coming weeks. That said, a sharp move for USDCAD looks unlikely today in our eyes, with manufacturing sales data for April the only Canadian data of note set to be published before the weekend.



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