Morning Commentary: Different Drivers, Same Result

Foreign Exchange - Morning Commentary
Different Drivers, Same Result
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Over the last 7 trading days in July, USDJPY moved down sharply as the yen strengthened against the USD in price action that was similar to the action seen with the euro and Swiss franc. 

Part of the reason for this yen appreciation could be attributed to the two day Japanese holiday that sidelined natural yen sellers.  Additionally, the fall in US yields has compressed the spread between US and Japan rates down to multi-decade lows.  This yield spread compression provides tailwinds to yen strength.  However, with the 10-year yield spread around 50 bps, the potential for further compression remains albeit on a limited basis.  Taken together, the drivers for the recent move in USDJPY are likely to fade but further yen strength is still expected as more medium term fundamental drivers should take over.   

Real interest rate differentials continue to tilt in the yen’s favor as Japan and the US are faced with different inflation outlooks.  Japan also continues to maintain a robust current account surplus and there has been a moderation in portfolio investment outflows. 

With regards to investment outflows, it must be acknowledged that the extended holiday likely exacerbated the recent drop in Japan resident’s overseas bond buying.  It is also expected that the Government Pension Investment Fund (GPIF) and other pension funds that mirror the GPIF will continue to reinvest maturing JGBs into unhedged overseas bonds. 

Nevertheless, the trend pace in outflows have slowed since peaking earlier this year.  Japan has also been diversifying its overseas bond purchases.  While foreign bond purchases have been heavily concentrated on US treasuries, more recent flows have been into European sovereign debt with Australian and Canadian debt surging despite Japan net selling US debt.  With the search for yield entrenched, this allocation shift could persist for a while. 

Overall, the material pullback in the pace of Japan’s overseas debt buying relative to record levels seen earlier in the year results in a more balanced flow picture and reduced an idiosyncratic factor that has been muting yen appreciation. 
  • According to news sources, Republicans and Democrats have agreed to have a deal by the end of the week.  If this happens, it would set up a potential vote by next week.  Republicans appear to have moved a bit on supplemental unemployment insurance, one of the more contentious issues, as Senate Majority Leader McConnell has indicated an extension of the full $600/week is possible.  Treasury Secretary Mnuchin reportedly offered an extension to the eviction moratorium but this extension still falls short of what Democrats want.  Election year pressures make an eventual deal the base case, however both sides still remain far apart on numerous issues so a deal this week won’t be easy. 
  • The US and China have agreed to high level talks on August 15 to review progress on their Phase 1 deal.  This raises the risk for headline risk.  Trump could see this as an opportunity to show US voters he is tough on China and distract from the administration’s handling of the virus.  For China’s part, it could use this as an opportunity to respond to health secretary Alex Azar’s visit to Taiwan.
  • US ADP employment data disappointed at 167K versus expectations for 1.2 million jobs.  However, last month’s number was revised up from 2.3 million to 4.3 million.  The non-farm jobs report will be released this Friday.  It should be noted that ADP data has been a poor indicator of what the non-farm jobs report will hold. 
  • The Bank of Thailand kept its policy rate unchanged at 0.50% in a unanimous decision as expected.
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