Yen Nears Record Low Vs Euro on Carry, Interest Rate Outlook

Kevin Du

Economic

Forex

Central Bank

Summary:

The yen is sliding faster against the euro than the dollar as speculation grows that the European Central Bank will take it slow in cutting interest rates because inflation remains elevated.

The Japanese currency has weakened 1.3% against the euro this month and is approaching its previous record low of 171.56 reached on April 29. While the Bank of Japan ended the world's last negative interest rate policy in March, its rate gap with overseas counterparts including the European Central Bank remains wide.

There has been some disagreement on the pace of likely moves among ECB members that has fueled investor expectations that changes will be gradual. Meanwhile, the UK pound climbed to the highest level against the yen since 2008 on the view that the Bank of England will also take its time due to lingering inflation.

The yen has weakened to 34-year lows this year against the dollar, but the risk of intervention by Japanese authorities to support the currency has caused the decline to slow. Japan is suspected to have bought yen for dollars in late April and early May.

The Japanese currency briefly spiked on Wednesday after BOJ policy board member Seiji Adachi acknowledged it's possible that yen weakness could spur price gains and prompt authorities to consider another rate hike earlier than expected. The fact that even Adachi, a noted dove on the board, hinted at more policy action bolstered expectations that an additional interest-rate hike is in the works.

Recent low volatility adds to headwinds for the yen because it will encourage investors to borrow more in the currency cheaply to invest in higher-yielding assets abroad, in a popular transaction called carry trade. Despite increases in Japan's 10-year government bond yield to the highest level in more than a decade, its German equivalent still offers more than 150 basis points of extra yield.

“The yen continues to see downward pressure from the carry trade,” said Yujiro Goto, head of Japan currency strategy at Nomura Securities Co. “The euro gets extra support from fundamental factors such as sticky service inflation pressure, re-acceleration of wage growth and the economic slowdown bottoming out. The ECB may cut rates in June but its cautious stance overall about the rate cut is another boost to the common currency.”

The ECB shouldn't rule out lowering borrowing costs at both in its June and July meetings, Governing Council member Francois Villeroy de Galhau said, pushing back against fellow monetary officials who are uncomfortable at the idea of consecutive cuts.

Inflation in the euro-zone is expected to have accelerated to 2.5% on year in May from 2.4% in April, according to median estimate in Bloomberg survey before data due Friday. In the UK, data last week showed consumer prices rose more than expected in April.

“There may be some more upside for the euro and the pound against the yen,” said Go Ohara, director of the FX trading department at MUFG Bank Ltd. “While some investors liquidate accumulated dollar-long positions, European currencies such as the euro and the pound have been bought, providing extra support.”

Some investors are betting on the chance that European currencies will gain further against the yen, trading options for the euro-yen with a strike price of 175.15 expiring in June, and the pound-yen with a strike price of 202 expiring in July, based on Depository Trust and Clearing Corp. data.

Source: Bloomberg

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Data Interpretation

On May 29, local time, GfK released the German consumer climate index, showing that the consumer confidence index came in at -20.9 heading into June, compared to an expectation of -22.5 and the previous reading of -24.

German consumer confidence continued to rise in June, improving for the 4th consecutive month. Among other things, Germans' views of the economic outlook improved significantly, income expectations rose slightly, the propensity to save fell significantly, and the propensity to buy edged up.

The rise in consumer confidence is mainly attributed to a significant drop in the propensity to save and a continued rebound in the consumption environment. The savings indicator fell to 5, down 10 from a month earlier. It was the lowest level since August 2023. Besides, continued declines in inflation, as well as sharp increases in wages, are increasing consumer purchasing power.

Income expectations rose for the fourth consecutive month in May, registering 12.5, but the rate of increase slowed compared to the previous three months. The rise in income expectations was driven by sharp increases in wages and mandatory retirement benefits, as well as a further decline in inflation.

The propensity to buy showed signs of "stagnation" in May and did not improve due to rising income and economic expectations, registering -12.3. The indicator has been stuck in the -20 to -10 range for almost two years and has yet to show any signs of recovery. The main reasons for the cautious consumption were the continued high energy and food prices, as well as the high level of uncertainty about the economic outlook.

May economic expectations rose significantly, recorded at 9.8. It is also the fourth consecutive increase in the index, indicating that Germany's economic recovery hopes are growing. Data from the German Federal Statistical Office suggested that the economy is expected to likely grow by a modest 0.2% in the first quarter of this year.

Germany GfK Consumer Climate in June

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Samantha Luan

Economic

Political

A nascent rally in the Indian rupee has room to run on expectations that Prime Minister Narendra Modi will secure a strong mandate to execute pro-growth policies.

The currency, which has been at the mercy of the central bank’s vise-like grip recently, is set for a breakout and poised for its best month in almost a year. It will rally through its peak in March and hit 82 per dollar by the end of 2024, according to Malayan Banking Bhd.

While the rupee is poised to strengthen, its gains may still be capped because of the Reserve Bank of India’s tight hold on the currency, guided by its goal to keep it stable and shield India’s export competitiveness.

“Under normal circumstances, we would view an election win for Modi as being positive for the rupee given that the country has prospered economically under his administration,” said Shaun Lim, a currency strategist at Malayan Banking. “However, RBI has had a preference to lean against the wind and keep the rupee stable and that any significant gains could be tempered by their policy leanings.”

A Big Modi Victory Seen Fueling Indian Rupee’s Nascent Rally_1

The rupee is seen gaining to 82.80 per dollar by year-end from 83.2513 on Wednesday, according to the median forecast in a Bloomberg survey.

Nevertheless, traders will look forward to the count of votes on June 4 as India’s seven-phase election that started in April is nearing an end, and a landslide majority for Modi’s party may support the rupee. Modi has pledged to boost infrastructure and expand welfare programs should he win a third term in office as he seeks to transform the nation into a developed economy by the mid-century.

The rupee is among Asia’s best performers this year, bolstered by about $6 billion in foreign inflows into local-currency bonds ahead of the inclusion of sovereign bonds into JPMorgan Chase & Co.’s emerging-market index in June.

“If we get a strong mandate for the government, that can lead to a return of foreign investor flows,” said Anindya Banerjee, head of research, currency and commodity derivatives at Kotak Securities in Mumbai. He sees the currency rising to 82.60 per dollar by end-June if the RBI allows.

Source：Bloomberg

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Warren Takunda

Economic

The Australian Dollar rose after the CPI indicator came in at 3.6% year-on-year, above the consensus estimate of 3.4%.

"April's above-consensus Australian CPI print has hit the local bond market and serves as a reminder that the Reserve Bank of Australia may not be done hiking," says Chris Turner, Global Head of Markets for UK & CEE at ING Bank.

The CPI indicator is a monthly measure of a portion of Australia's inflation basket and gives economists a good sense of how the complete quarterly inflation print will pan out.

"AUD/USD rose modestly by about 0.2% to near 0.6665 after the stronger than expected Australian April CPI indicator," says Carol Kong, a strategist at Commonwealth Bank of Australia.

The Pound to Australian Dollar exchange rate is softer on the day at 1.9168 as it continues to give back some of the previous week's advance. "We have a long-standing bearish call on EUR/AUD and we see the recent run-up in GBP/AUD from 1.90 to 1.92 being completely reversed over the next month," says Turner.

The Australian Dollar has been one of the best performers in the G10 currency family over the past two months, helped by fading expectations for RBA interest rate cuts. These inflation data will only reinforce the market's belief that the RBA won't cut until the first quarter of 2025, well behind other central banks.

Australian Dollar Boosted by Inflation Print_1

Above: Australian monthly CPI tracker. Image: Commonwealth Bank of Australia.

"It is worth noting a tension in the forecast which suggest an upside surprise in the underlying fundamentals for inflation," says Justin Smirk, Senior Economist at Westpac. "The quarterly surveyed clothing & footwear prices were stronger than expected which will see an upwards revision to these components in our June quarter CPI forecast. Assuming all else is held constant, this would suggest an upward revision to our forecast."

Smirk notes that core inflation measures lifted from 4.1% to 4.2%, while the Trimmed Mean measure lifted from 4.0% to 4.1%, the fastest pace since the 4.6% reported in November 2023.

This is the last inflation print that the RBA will receive before its June meeting, and there is nothing here to suggest they will drop their cautious approach.

A 'higher for longer' RBA would mean the AUD can continue to rely on interest market dynamics to deliver outperformance.

Source: Poundsterlinglive

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Cohen

Central Bank

Economic

Another hot inflation print on Wednesday prompted traders to bid up bond yields and ditch equities as economist mulled the growing risk that the Reserve Bank of Australia may need to lift rates further to pull inflation down to target.

The consumer price indicator rose to 3.6 per cent in April from 3.5 per cent in March – its highest level so far this year – overshooting expectations for inflation to cool to 3.4 per cent and above the RBA’s 2 per cent to 3 per cent target.

Robert Carnell, regional head of research at ING, said the inflation report was not what the RBA would have wanted to see ahead of its next meeting in mid-June, given the string of hotter-than-expected inflation figures in recent months.

“We wrote some weeks ago that we were just one bad inflation report away from stripping out our remaining cash rate cut forecast for 2024, and two bad reports from considering a hike,” he said. “The first of those conditions has now been achieved.”

Following the news, Australian bond yields rose with the three-year rate up 8 basis points to a one-month high of 4.11 per cent and the 10-year return added 7 basis points to 4.43 per cent.

Yields for Australian government bonds had already jumped ahead of the report, following weak demand for two US treasury bond sales overnight.The tepid reaction from US traders came ahead of the core personal consumption expenditure data due later this week which is expected to shine a light on the rate path for the US Federal Reserve.

The Australian sharemarket sold off on Wednesday, with the S&P/ASX 200 on track for its worst one-day drop this month. The Australian dollar briefly climbed to US66.65¢ after the inflation report but was unable to keep its gains.

No rate relief in sight

Money markets, meanwhile, modestly raised the probability that the Reserve Bank will lift the cash rate to 4.6 per cent this year from 4.35 per cent.

They imply a 20 per cent chance of a rate rise by September, from 16 per cent before the inflation data. They’ve also pushed back the likely timing of the first rate cut to December 2025 from May 2025 indicated just last week.

Mr Carnell said ING was considering whether the risk had “shifted to the possibility of some further RBA tightening”, despite most economists predicting the next move in the cash rate to be lower.

“We are now only one bad inflation report from amending our forecasts to include some additional tightening,” he said.

UBS said that there was still a lingering risk the RBA will raise rates by 25 basis points over coming months, while Betashare’s David Bassanese said there was “at least” a 30 per cent to 40 per cent chance of higher borrowing costs “if the disinflationary process fails to resume anytime soon”. RBA ‘One Bad Inflation Report’ Away From Hiking, Say Economists_1

RBA ‘One Bad Inflation Report’ Away From Hiking, Say Economists_1

Judo Bank advisor and economist Warren Hogan – who has been calling for more rate hikes for much of the last year – said April’s unexpected pickup in inflation could prompt the RBA to lift the cash rate as soon as next month.

“These results will test the RBA’s patience,” Mr Hogan said. “The RBA was very close to hiking the rate earlier this month. This number could tip them over to raising rates at their next meeting.”

Mr Hogan said his forecast for two rate increases in 2024 was based on the assessment that to get inflation back down to 2.5 per cent, the cash rate needed to be around 5 per cent.

That is “in line with other similar economies’ interest rates,” he said. “Today’s data and ongoing increases in employment suggest this is still the right view.”

ANZ’s senior economist Catherine Birch said the bank still expected the RBA to cut in November, but conceded that risks of another increase to the cash rate were rising.

“We will get a better gauge on domestic price pressures, and the implications for the policy outlook in the May data,” she said, adding that the results for the upcoming national accounts and this month’s unemployment figures would be “critical” ahead of the RBA’s next meeting.

“It increasingly looks like the RBA will need to see new information in the data to convince them to remain patient on rates,” she said. “If unemployment dips back to 4 per cent or lower in May, the RBA will find it hard to keep rates at 4.35 per cent.”

Source：Financial Review

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Warren Takunda

Economic

The Chinese yuan traded on the mainland hit a six-month low against the dollar of 7.2488, highlighting the divergent monetary policies of the world's two biggest economies.

High U.S. interest rates and efforts to stimulate the domestic economy pose a continuing challenge to the yuan despite the onshore exchange market trading within a band fixed by China's central bank.

The onshore yuan weakened to 7.2488 against the dollar, falling past the 7.2472 level set on April 25 and hitting its lowest point since November last year. The People's Bank of China (PBOC) lowered its reference rate to 7.1106 per dollar on Wednesday morning, its lowest level since January 23, when the reference was set at 7.1117, allowing the yuan to weaken. The onshore yuan is held within a trading band of plus or minus 2% from the reference rate.

The offshore yuan, which is not constrained by the trading band, also declined to 7.2667 against the dollar on Wednesday, a low since April 29.

Analysts said the downward pressure on the yuan is driven by the dollar's strength, underscoring the contrasting monetary policies of the PBOC and the U.S. Federal Reserve. "There is a divergence between monetary policy biases in the U.S. versus China," said Ray Attrill, head of FX strategy at National Australia Bank.

Chinese Yuan Falls to Six-Month Low on Dollar Strength_1

The Fed has kept interest rates at their highest level in more than two decades, and sticky inflation has left forecasters divided on whether the central bank will start cutting rates by the end of the year. Federal Reserve Chair Jerome Powell said in May that inflation is falling more slowly than expected.

The PBOC kept its benchmark interest rates, the one-year and five-year loan prime rates, unchanged in May. But it has taken measures aimed at reaching China's 5% economic growth target for 2024, while battling a decline in housing prices. In May, the PBOC scrapped minimum interest rates for mortgages, lowered minimum down payment ratios and set up a 300 billion yuan financing scheme to encourage local governments to buy up unsold homes.

Some analysts expect more easing this year, such as a cut in the reserve requirement ratio, which determines the minimum ratio of deposits that banks must hold as reserves.

"Unless the U.S. actually shows a more dovish stance, the depreciation pressure for the [yuan] will probably persist for a while," said Gary Ng, a senior economist at Natixis.

Source: NikkeiAsia

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Thomas

Economic

Bond

Forex

Markets

Global bonds trading took a slow start after a long weekend in the US and the UK. Yields initially lost a few basis points. However, US Treasuries were hit by a triple whammy as the US session preceded. Mid-morning in the US, Fed's Kashkari confirmed the more hawkish tone from last week's Fed Minutes. The odds for the Fed to raise rates currently are quite low, but not completely off the table. In any case, the Fed needs (much) evidence before becoming confident to start easing. More or less at the same time, US consumer confidence unexpectedly reaccelerated from 97.5 to 102.

Consumers' assessment on the economy wasn't unequivocally positive, but expectations on income and spending remained positive. Inflation is hardly seen slowing. The consumer confidence report and the Kashkari comments triggered a first down-leg in US Treasuries. Later, 2-y and 5-y US bond auctions only met with mediocre buying interest, further propelling rates. In a broader perspective, the curve move was interesting.

Despite poor auctions of shorter maturities, this time the long end of the curve underperformed (2-y +3 bps, 10-y +8.5 bps, 30-y + 9.6 bps). With money markets already discounting only 1 rate cut this year, investors apparently are caution to place additional bearish bets at the short end of the curve, turning the focus further out. Also keep an eye at the 10-y real yield, which jumped more than 6.5 bps yesterday. German yields also changed course later in the session. Initially, some more hawkish ECB members (Knot, Holzmann) sounded quite confident that th disinflation process is gaining traction.

Still, the move in the US at the end of the day also raised German yields between 2 bps (2-y) and 4.5 bps (10-y). US equities hesitated, but in the end held strong (Nasdaq +0.59%, new record close). The rise in yields helped to dollar to hold above first support levels. Admittedly, gains could have been bigger (DXY 104.61, EUR/USD close 1.0857 after testing 1.0890 intraday).

This morning, Asian equities suffer more from the sell-off in US Treasuries than was the case yesterday on WS. The broader rise in LT-yields also spreads to Japan (10-y yield 1.08%). The dollar tries to extend gains. The eco calendar is thin today, expect for the German CPI data. Monthly HICP is expected to rise a modest 0.2%, but unfavourable base effects might rise the Y/Y-measure to 2.7% from 2.4%. In case of an upward surprise, after yesterday's global bond move, we're keen to see the reaction at the long end of the curve. The German 10-y yield isn't far away from the 2.65% April top. The US Treasury will sell $44bn 7-y notes. EUR/USD is locked in the 1.08/1.09 range.

News & Views

Australia's monthly CPI unexpectedly gained traction in April. The yearly figure picked up from 3.5% in March to 3.6% compared to a 3.4% consensus. It is the second month in a row where annual inflation printed an increase, extending a potential bottoming out process that's been going on since December last year. It underscores the need for the central bank to remain vigilant on the matter, even as yesterday's retail sales suggest consumer fragility.

Australia's Bureau of Statistics singled out housing (4.9%, with rents rising 7.5%), food (3.8%) and transport (4.2%) as some of the major contributors. Electricity prices rose 4.2% but the government's Energy Bill Relief Fund depresses the actual pressures. Without the rebates, prices would have risen 13.9%. Excluding categories including food & vegetables as well as holiday travel, core inflation in April rose by 4.1%, the same as in March. Core CPI in February hit a 2-yr low of 3.9% before creeping marginally higher. Australian swap rates rise between 3.6 and 4.7 bps. AUD/USD erased an earlier minor gain to trade more or less stable around 0.665.

The IMF in a statement this morning lifted Chinese growth prospects for 2024 and 2025. A stronger-than-expected expansion in the first quarter of the year is reflected in an upward revision to the annual target from 4.6% to 5%. Next year's GDP growth would amount to 4.5% from 4.1% seen earlier. It nevertheless urged the country to address the ongoing housing slump that's weighing on domestic demand and confidence. Aside from fiscal support, China's low inflation also creates room for additional monetary support, it said.

Authorities are wary to do so, however, fearing that increasing the monetary spread with the likes of the US may trigger capital outflows, pressure the yuan and create financial instability. The currency this morning already hits the lowest level since November at around USD/CNY 7.248. CNY hit a 17-yr low in September last year at USD/CNY 7.35.

Graphs

GE 10y yield

ECB President Lagarde clearly hinted at a summer (June) rate cut which has broad backing. EMU disinflation continued in April and brought headline CPI closer to the 2% target.. A more bumpy inflation path in H2 2024, the EMU economy gradually regaining traction and the Fed's higher for longer US strategy make follow-up moves difficult. Markets have come to terms with that.

US 10y yield

The Fed in May acknowledged the lack of progress towards the 2% inflation objective, but Fed's Powell indicated that further tightening was unlikely. Soft US early month data triggering a correction off YTD peak levels. However, the Fed minutes still showed internal debate whether policy is restrictive enough. Sticky inflation suggests any rate cut will be a tough balancing act. 4.37% (38% retracement Dec/April) already proved strong support for the US 10-y yield.

EUR/USD

Economic divergence, a likely desynchronized rate cut cycle with the ECB exceptionally taking the lead and higher than expected US CPI data pushed EUR/USD to the 1.06 area. From there, better EMU data gave the euro some breathing space. The dollar lost further momentum on softer than expected early May US data. Some further consolidation in the 1.07/1.09 are might be on the cards short-term.

EUR/GBP

Debate at the Bank of England is focused at the timing of rate cuts. Most BoE members align with the ECB rather than with Fed view but slower than expected April disinflation and a surprise general election on July 4 complicated matters. A June cut in line with the ECB looks improbable. Sterling extends a recent bull rally. A test of EUR/GBP's 2024 YtD low (0.8489) is possible. We expect this important support level to hold.