Morning Commentary: Wait and See

Foreign Exchange - Morning Commentary
Wait and See 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Bank of Japan will announce its latest rate decision tonight.  After taking aggressive action with its COVID-19 response from March through June, it is widely expected that the bank will leave all policy targets unchanged.  The summary of opinions from the June meeting supports this with the majority of members believing the bank has done enough to cushion the COVID blow for now.

The bank’s confidence in taking a wait and see approach has also been aided by upbeat economic data and government actions that have helped corporate conditions.  To this point, bank lending has risen 6.5% YoY in June, the fastest growth in rates since this measure began in 1991.  Given this, there remain areas of weakness especially in the sectors hard hit by collapses in tourism and COVID-19 related social distancing.  Longer term, BoJ Governor Kuroda has effectively ruled out rate hikes before his term is scheduled to end in April 2023.   

As a result, the market’s focus will be on the bank’s yield control management with specific emphasis on the super long end.  The BoJ has committed to keeping its 10-year yield around zero, but it has expressed a desire to see a steeper curve.  Expect Governor Kuroda to be asked about this at his press conference.  So long as markets remain orderly, there is no reason to think this stance will change.  

Regarding USDJPY, it has been range bound since the beginning of April.  However, after the summer, yen volatility could rise.  The risk for early Japanese elections/change in leadership continues to rise, and of course, the US has its presidential election.  On the monetary front, the markets will likely gain further clarity around the implementation or lack thereof of further stimulus (forward guidance/yield curve control).  All these factors, and more, have the potential to shake USDJPY out of its current subdued trading range. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • California Governor Newsom’s decision to close all indoor entertainment delivered a reality check to markets and contributed to the risk off tone that took over late in yesterday’s trading session.  California, Texas and Florida represent three of the states hardest hit by the virus and represent ~30% of US GDP.  With much of the re-opening efforts on hold or reversed, there are serious downside risks to Q3 GDP.  
  • In a show of support, Vice President Pence told governors that the White House will back them on any measures taken to control the virus.  Outside the US, Hong Kong tightened its rules and Tokyo is considering declaring another state of emergency. 
  • US-China tensions took another step up with the US rejecting China’s claims in the South China Sea.  This largely symbolic challenge marks the reversal of a previous policy not to take sides in maritime disputes in the area.  On China’s side, the country announced that it was imposing sanctions on Lockheed Martin after the US approved a deal to supply missile parts to Taiwan.   
  • The US posted a record budget deficit of $864 billion in June.  This one-month number is almost as much as the deficit for all of 2019 and brings the 12-month total deficit to a record high of $3 trillion with no signs that this trend will reverse.
  • Positive news around Europe’s recovery fund continues with Italy reportedly willing to accept more stringent criteria required by the Frugal Four.  The EU will hold its’ summit this Friday and Saturday where it will attempt to strike a deal on the recovery fund.  
  • US core CPI beat expectations at 0.2% versus expectations for a 0.1% rise. 
  • Eurozone industrial production numbers missed expectations, rising 12.4% MoM against expectations for a 15.0% rise.  UK GDP data was also disappointing as it grew 1.8% MoM against expectations for a 5.5% increase. 
  • China’s trade surplus was smaller than expected at $46.42 billion vs expectations for $59.60 billion.  
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