By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Putting the USD Carriage Ahead of the Yield Horse?
A second leg-up for USD may hastily be framed as a continuation of the FOMC reaction as the “Dot Plot” baking not one, but two, 2023 rate hikes (from none in March) is digested.
But that misses critical nuances, if not an outright mis-characterisation. For one, a key difference that ought to matter is that USD surge in the immediate aftermath of the FOMC was in conjunction with (if not led by) resurgent yields (10 UST up 8-9bps); in contrast to overnight outburst of USD strength in spite of falling yields (real and nominal).
So, while your scribe not only conceded, but promoted, the view of a stronger USD post-FOMC in the ‘Week Ahead’, this was premised on higher real (and nominal) yields; hence the “keeping it real” reference). But now, the USD carriage is placed in front of the yield horse.
This horse-carriage conundrum showed up in USD/JPY; with the initial surge to high-110 fading back to low-110 in response to the sharp (6bp) pullback in UST yields.
Admittedly, another way to frame that may be Cross/JPY downward pressures checking USD/JPY. For those hung up on the USD carriage (obscuring the yield horse behind), the question may appear to be whether this bout of USD strength is a durable inflection. But this is an incomplete, careless question. Whereas a fuller picture of the USD carriage requires a take on the yield horse. In particular, USD bull reliance on rising real yields.
Admittedly, for now, the surge in the USD appears to be taking some froth off commodities and one-way bets. But this is more a post-FOMC reflex than it is considered realignment. Afterall, Jerome Powell did ask of markets to hold their horses on hawkish conclusions about the “Dot Plots”. Now, to get a grip on, and feel for, the carriage!
BoJ: Dovish Hold & JPY Gauge
This highlights how the bumpy emergence from Covid, what becomes increasingly important is not the absolutes of monetary policy; but the relatives. Not the least of which is how a central bank’s exit strategy measures up against, and specifically lags, the Fed’s.
On which the ECB presented a master-class on this last week;
i) simultaneously delivering upgrades to economic forecasts, yet;
ii) assuring markets that they will not exit prematurely; even sneaking in the reference of the Euro-zone recovery not being in the same vicinity as that of the US.
Upshot: BoJ will have to address both the stark realities (of US recovery prospects getting well ahead of Japan both on vaccination lead and fiscal out-run); and market perceptions of BoJ’s constraints relative to the Fed’s “flexible average inflation” approach to policy.
With the Fed turning more noticeably state-dependent, a low-hanging fruit may be for the BoJ to remain unequivocally committed to (with time guarantee); to up its dovish chops.
And the JPY will be a key barometer of the BoJ’s “success” in establishing its relatively more dovish position.
And so, preventing unwelcome JPY appreciation from any (mis-)perceived BoJ message may be the low bar for the BoJ.
Credit: Mizuho Bank Ltd