GBP JPY - FUNDAMENTAL DRIVERSGBP
FUNDAMENTAL BIAS: WEAK BEARISH
1. Monetary Policy
At their May meeting, the BoE delivered on expectations by raising the bank rate by 25bsp to 1.0%. There was an initial hawkish surprise as the vote split was 9-0 (no dissent from Cunliffe) and 3 of the 9 MPC members voted for a 50bsp move at the meeting. However, the hawkish reaction soon faded as it was also revealed that 2 of the 6 members who voted for a hike thought that this marked the end of the current hiking cycle. The dovishness didn’t stop there though as the BoE revised up their forecasts for peak inflation to >10% which added to the stagflation fears as the bank also saw possible GDP contraction in 2023. Furthermore, the bank took their first real stab at overly aggressive STIR pricing for the 2022 rate path by saying the current path would imply a big undershoot of their 2% inflation target in 2023 and was later backed up by Governor Bailey who said even though he thought rates should continue to rise he didn’t agree with those who think the MPC should be raising interest rates by a lot more. As the bank rate was raised to 1.0%, the markets expected some clarity from the bank on their plans to reduce the balance sheet . However, the bank decided to play for more time and said the bank will provide an update on their plans at the August meeting, pushing back expectations of active QT from Q2 to Q3. As a result of the overall dovish tone, Sterling fell to its lowest levels since 1Q21. The meeting confirmed market calls that the bank would look to hold rates steady after reaching 1.50%.
2. Economic & Health Developments
With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces stagflation risk, as price pressures stay sticky while growth decelerates. That also means that current market expectations for rates continues to look too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.
3. Political Developments
Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
4. CFTC Analysis
Bearish signal from all 3 participant categories with aggregate positioning (large specs, leveraged funds & asset managers) still below 1 standard dev from the 15-year mean. Keep in mind that the CFTC data was updated until Tuesday 3 May which means the flush lower in Sterling following the BoE is not reflected in this data yet. With both price action and positioning looking stretched, we don’t want to chase GBP lower right now.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
The BoJ kept all policy settings unchanged at their April meeting, which was in line with broad consensus expectations, but given the price action after the event did imply that a sizeable chunk of the market was expecting something more (us included). Due to the JPY weakness in recent weeks, markets wanted to see whether the bank would potentially increase their Yield Curve Control target band from 0.25%--0.25% to 0.50%--0.50%. But the bank decided to stick to their guns and maintain their ultra-easy policy despite the rapid depreciation of the JPY. The bank doubled down by saying they will conduct special open market operations on every working day as needed to keep the 10-year GBP capped at 0.25%. As expected, the bank reiterated their view that rates will stay low for the foreseeable future and won’t hesitate to add stimulus if the economy needs it. On the JPY, Gov Kuroda made familiar comments by saying they desire stable currency moves which reflect economic fundamentals. As a result of the bank’s inaction, all eyes will now be on the MoF to intervene if the rapid depreciation of the JPY continues.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite is jittery. Even though that doesn’t change our med-term bias for the JPY, it does means we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place. In this environment there could be mild upside risks for the JPY if US10Y corrects, but we shouldn’t look at the yield correlation in isolation and also weigh it alongside risk sentiment and price action in other safe havens.
4. CFTC Analysis
Some increase in Large Spec & Leveraged Fund net-short again, with aggregate JPY positioning still close to 2 standard deviations away from a 15-year mean. Even though the med-term outlook remains bearish , the risk to reward to chase the currency lower from here is not very attractive.
