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Contrasting Forces in Euro and Yen Again - Global Exchanges

FICC Podcasts 29 mars 2022
FICC Podcasts 29 mars 2022


Disponible en anglais seulement

In this episode, we discuss the shocking weakness exhibited by the yen over the past few days as manifest by the move in USDJPY above 125. We also discuss the influences that have led to the pop above 1.11 in EURUSD.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Disponible en anglais seulement

Greg Anderson:

Hi, welcome to episode 38 of Global Exchanges. A podcast about foreign exchange markets and related issues. I'm Greg Anderson. For this week's episode, my co-host, Stephen Gallo and I, will discuss the shocking weakness exhibited by the Japanese yen over the past few days as manifest by the move in dollar/yen above 125. We will also discuss the influences that have led to the pop above 1.11 in euro/dollar. The title of this episode is Contrasting Forces in Euro and Yen Again.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London based FX strategist. Welcome to Global Exchanges presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's co-host.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/GlobalExchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates or subsidiaries.

Stephen Gallo:

Greg, thanks for the intro. The date is March 29th for today's podcast. And we have some movement again in the foreign exchange markets, but like last week we have to focus on the yen again. So for some background, since March 22nd, the last time we did a podcast, the yen has fallen a further 1.4% against the dollar. Since that date, we've also seen a very powerful rise in global yields, but we also saw the BOJ reinforced the top of its target range for the 10 year JGB yield. So if anything, that has kind of helped widen the rate differential between the dollar and the yen.

Stephen Gallo:

We've also had some movement in the euro too, but it has moved in the opposite direction to the yen since the close on March 22nd. So we saw euro/dollar consolidate around the 1.10 level for about four days after our last podcast, but today we had a spike to levels above 1.11 on a positive tone, or at least the market's interpretation of positive tone coming out of the resumption of Russia Ukraine negotiations. So the pair euro/dollar is up by 0.7% since our last podcast.

Greg Anderson:

Right. So we made the euro/yen cross the focus of our last podcast which we titled, The Euro/Yen Rally Makes No Sense. At that point, we were looking at euro/yen at about 133 the figure. After discussing the issues in the pair at that point, we concluded that while the pair probably 'belongs in the 120s' it was still too early to sell it because it was seemingly mid spike. So here we are today at 136 and change with a spike high yesterday of call 137.50. I still think this is a wrong price, but to be fair to the FX market, we should probably do a bit more to deconstruct this week's move.

Stephen Gallo:

Okay. Greg, look, I want you to take us through the mechanics of the move in dollar/yen from the 120 level, which was basically on the day of our last podcast, to the high for the cycle so far, which was a little bit above 125 on Monday, that's yesterday. In the back of my mind and I asked you about this last week, I still have this question of why the BOJ decided to give the green light to this move in the yen with the clear risk of the depreciation occurring rapidly, given that so many other central banks are in tightening mode. So take us through the mechanics of the move on the one hand and what you think Japanese officials are thinking right now.

Greg Anderson:

In the lead up to our last podcast, we'd already seen basically a five big figure move from 115 to 120 that I would attribute to the hawkish Fed on March 16th, followed by the dovish BOJ on March 17th. I'll admit that at that point, I sort of thought that we'd get a consolidation in dollar/yen somewhere, 120 to 121, because five big figures was already a sizable move for a pair that says low volatility as dollar/yen. But what ended up happening late last week, and then during the thin Asian trading session on Monday, is that global bond yields made a major move higher. I would call the US curve the epicenter of the global rate move. At yesterday's peak, both two year and 10 year Treasury yields had added about 25 basis points from where they were at our last podcast.

Greg Anderson:

And just focusing in on 10 year yields, normally a noteworthy move in US dollar denominated 10 year yield tends to propagate out so that we see something like 80% of the move show up in highly floating rate curves like in Aussie and CAD. And then maybe 50% show up in euro, and then something like 20% show up in yen 10 yields. That's exactly what happened. So US 10 year yields up 25 basis points and Aussie 10 year yields also up 25 basis points. CAD 10 year yields up about 20, euro about 10. And so with all that, I would've expected something like five basis points or so higher in 10 year JGB yields, but there was a problem with that. We started this global yield spike with a JGB yield on the 10 year at 0.22%. So adding five basis points would take us through the BOJ's cap, which is 0.25%.

Greg Anderson:

We hit the BOJ's cap on Monday morning Asia Time, and the BOJ did what it mechanically had programmed itself to do, it held two auctions yesterday and then two more auctions today. Those auctions are there to take up or buy an unlimited amount of 10 year JBS at the yield of 0.25%. So far, I mean, there has been take up at three of the four auction. Total, a little over 4 billion USD equivalent worth of JBS purchased. So to put it another way, the BOJ has just done about 4 billion in QE at a time when the Fed and most other central banks have stopped QE and shifted market expectations towards QT. This simply has got to be bad for a currency. So in thin trading market players pushed the narrative and got dollar/yen to spike above 125.

Stephen Gallo:

Okay, Greg. So as you said, we got the spike above 125. So let me repeat the second part of my question, what do you think Japanese officials are thinking now?

Greg Anderson:

That's a great question. There may possibly be some disagreement. BOJ Governor Kuroda said 12 days ago that a weakening yen was net good thing for the Japanese economy. But today we got comments from Finance Minister Suzuki, that I would characterize as verbal intervention. He basically said that it was not yet known whether the big decline in yen was a good thing for the economy. Put another way, he was asking the FX market to please pause the move. Now from here forward, I'd say the FX market will be highly attentive to anything that Kuroda might say over the next few days. Admittedly, he doesn't have a program speech until April 11th, but I'm sure that date is bookmarked. I could be wrong, but my guess is that Kuroda also is hoping that dollar/yen doesn't really push through 125, at least not until the market and the economy has had enough time to digest the move that we've already had.

Greg Anderson:

I could be wrong on this too, but I think he probably would be willing to support a widening of the BOJ's target band for the 10 year yield. So that instead of being as it is now 0.00% plus or minus 25 basis points, it maybe would get widened out to something like plus or minus 40 basis points. And I'll point out there is precedent for such a widening the tolerance band, at one point was at plus or minus 10 and got widened to plus or minus 25.

Greg Anderson:

I could even go further and argue that the whole yield curve control mechanism that got put into place when dollar/yen was 103 and falling. At this stage it's unnecessary, but I don't know that Kuroda will quite get there. I do think though he would probably be okay with band widening if it turns out that the mechanics of defending this 25 basis point cap polls dollar yen up through 125 and further, and it seems to be semi-permanent. At any rate with that fun moment on the hot seat, let me turn the table, Stephen. We got a sneak preview of what a ceasefire might do to European currencies earlier today. Please walk us through that.

Stephen Gallo:

We did indeed, Greg, get a little sneak preview of what a ceasefire might do to European currencies earlier today. So to mention the theme of the podcast, we have the yen moving lower and the euro appreciating. I'm going to go back to the Macro monthly piece we published on March 17th. And in that piece, we covered three possible scenarios for the war in Ukraine. One was a frozen war. Two was a ceasefire agreement with a path to sanctions being lifted. And the third was a ceasefire agreement, but with many sanctions being made permanent. When we published that piece on March 17th, euro/dollar was around the 1.11 level, which is basically where it is now. And we said that at that level, the FX market, euro/dollar in particular, was partially priced for some type of resolution. But we were pretty cautious on the euro in general and on the risks of an escalation. And I think we got bouts of escalation in between March 17th and just prior to today.

Greg Anderson:

You covered euro/dollar, but let me interject with a question of the Swedish krona, the Polish złoty, Hungarian forint, how did they respond to the seemingly hopeful Ukraine War news today?

Stephen Gallo:

Greg, that is a good question because it gives more insight into what investors were thinking. So as mentioned, we have euro/dollar now sort of at what we've been calling the 50/50 mark, but we've also seen impressive strength in peripheral European currencies. The Swedish krona is up 2% today alone, the Polish złoty up 1.6%, and the Hungarian forint is up by at very large 3%. Some of that is a move based on low liquidity, but we've been arguing that low participation was holding back downside in euro/dollar. But despite that it does look as if the balance of opinion in the FX market was that there would be an escalation of war pressures. So a lot of these peripheral currency shorts versus the dollar have been unwound or partially unwound or run into stops as a trader might say.

Greg Anderson:

So, Stephen, do you trust today's seemingly hopeful news?

Stephen Gallo:

Greg, it's tough for me to think that this is the end of the conflict as horrible as it is, because I haven't yet seen evidence of either side moving significantly to deal with the red lines hanging over the talks. And I think they mainly pertain to ultimately control of parts of Eastern Ukraine and Southeastern Ukraine, but really it's too difficult of a call to make. My conviction is quite low. Russia has clearly failed to achieve its key objectives in Western Ukraine. And I think the financial markets are aware of that, so some investors are looking this as a major turning point in Ukraine's favor. But it still seems to me as if a full Russian withdrawal is a low probability scenario, but other factors could intervene and change that too. We just don't know. It's very difficult call to make, and I wish it didn't have to make it.

Stephen Gallo:

But let me rehash the levels for euro/dollar we provided with our scenarios. I think if the talks break down, euro/dollar would be back at 1.09 pretty quickly. If a cease fire agreement is reached, I would be concerned about its durability, normally quite skeptical as a person. But in that scenario, euro/dollar would rally quickly to 1.12. We might even get an extension to 1.13. But after the ceasefire, I think the main issue, of course other than the ceasefire breaking down, is the effect of the sanctions and the increased downside with risks for Europe's economy which have built up over the course of March. I don't think those downside growth risks are going to dissipate even if the war ends tomorrow. I mean, they're not going to go away. They're still going to be a factor that weighs on growth this year. But in order for, I think, the rally in euro/dollar to extend back to 1.14, which is where the pair was basically trading prior to the war, I think a lot of the sanctions need to be removed or the powers that impose the sanctions need to give convincing signals that that's the path they're headed towards.

Stephen Gallo:

I'm skeptical personally that's going to happen, but maybe it would be a good time for me to toss it over to Greg. Shouldn't we be concerned about the long term energy supply and security issues for Europe that are here, as well as the cost of transitioning and diversifying sources of energy? Then of course there is the hit to net trade as well, which is a big factor for Europe.

Greg Anderson:

So, Stephen, it sounds like from what you're saying, that if we get an extension of the pop higher in euro/dollar, that would be a good sell juncture. I tend to agree with that. And I agree with it on the oil front too. I would say that if we get a piece dip in the price of oil to $90 a barrel or something like that, I don't think it would stay there for very long. Inventories are very tight, demand is held up reasonably well while we've been above $100 a barrel. And I think OPEC+ would like to keep the price of oil around a hundred. So the price hit to Europe's trade balance would remain. So if I could, I'll go back to where we started, and that was with euro/yen. It's at the wrong price at 136 right now, although it could still spike up to 138. And so we're left to stand aside when we make sure that spike won't extend further, but the right price for euro/yen is still somewhere in the high 120s.

Stephen Gallo:

I think you're right, Greg, even with more fiscal support for EU countries, from EU backed issuance, which I think is going to happen sooner or later, a lot of the Euro's core fundamentals will weigh on the currency as they look now in the current global environment, which let's face it, was difficult even before the war started. Why don't we wrap up episode 38 here. Thanks for listening until next time.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts@bmocm.com/GlobalExchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are some reported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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