Japanese equities continued to rebound this morning and futures are pointing to a positive open in US and European equities, with the latter having been a laggard in the recovery so far. From a purely macro angle, we remain cautious about big risk-on rallies before the key US CPI risk event (next Wednesday) is cleared. That said, a stabilisation after the big correction around the weekend should be enough for most FX pairs to start reconnecting with rate spreads and fundamentals.
From this perspective, the dollar looks vulnerable. We believe markets may be reluctant to take the year-end Fed policy rate much above 4.50%; that’s because 100bp of easing is probably linked to US macro, with anything extra (which has now been priced out) linked to expectations for some sort of intervention by the Fed to help the stock market.
That means the rebound in USD 2-year OIS rates to 3.75-80% may struggle to find much more momentum, and the dollar may be left with a short-term rate advantage around 40bp lower compared to just 10 days ago. We expect this will drive the dollar lower against most pro-cyclical currencies amid a potential further stabilisation in risk sentiment and a lack of market-moving data this week.
The safe-haven Japanese yen and Swiss franc probably remain a bit vulnerable in the near term. It is now widely believed most JPY speculative shorts have been trimmed, and we wouldn’t exclude the net positioning in USD/JPY may now be close to flat. That places the yen in a position to trade more on rates and global risk sentiment, and Bank of Japan Deputy Governor Shinichi Uchida’s pledge not to hike rates if markets are unstable paves the way for more JPY weakness into next week’s US CPI. We cannot exclude that USD/JPY tests the 150 mark before mid-next week.
Francesco Pesole
