European FX roundup; BOJ meeting preview
The USD Index (DXY) has been firm since the start of 2020. With a China-US trade truce in place, the pressure for the Fed to reduce rates again has been substantially reduced. The strength of the DXY is coming from the weaknesses in its major components. The Japanese yen has depreciated to around 110 on an improvement in risk appetite. The British pound is under pressure from increased bets for a Bank of England rate cut. Speculators have unwound their (short GBP) bets for a hard Brexit on January 31 but are not confident of a soft Brexit outcome on December 31. As far as the BOE is concerned, a 2020 is not assured in spite of the reduced uncertainties. The risk remains for GBP to trade below 1.30 again.
The euro is less worried about a Eurozone recession but is not expected to rebound like in 2017. The European Central Bank will, at this week’s meeting, likely affirm its easing bias but acknowledge the need for vigilance over possible side effects of its present easing measures. It will kick off a year-long strategic review which will be looking to introduce some flexibility to achieving its price stability goal via a symmetric inflation target. With interest rates negative rates to stay this year, speculators have started to consider the euro as another funding currency. Hence, the euro has scope to stay lower for longer around 1.10 or below.
BOJ meeting preview
The Bank of Japan is expected to stand pat tomorrow. GDP growth should have contracted sharply by more than -5% (Qoq saar) in 4Q19, in the aftermath of the October sales tax hike and the typhoon disaster. CPI inflation should have remained weak at the sub-1% level as of Dec19.
That said, the more recent developments, including the China-US trade deal, the bottoming of global electronics cycle and the weakening of the yen, should alleviate the pressure for the BOJ to further ease monetary policy. On account of the JPY13tn fiscal stimulus package proposed by the government in Dec19 to restore growth momentum, the BOJ may slightly revise up its FY20 GDP growth forecast during the quarterly outlook report this week (current: 0.7%).
In the bond market, the 10Y JGB yield has been hovering closely around the mid-point of the BOJ’s ±0.2% target range in the past one month, allowing it to keep the quantity of JGB purchases unchanged during the January operation plans. The bond supply pressure stemming from the government’s fiscal stimulus appears to be manageable. Funding through the supplementary budget requires an issuance of deficit-covering bonds worth JPY2.2tn. Under the general budget, the amount of JGB market issuance will stay roughly unchanged in FY20, with the increase of issuance concentrated in the 40Y space (JPY0.6tn).
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