US
The upswing in crude oil prices stalled on reports that US and Iranian negotiators were exploring a seven-day deal to reopen the Strait of Hormuz. The modest pullback in energy prices eased the global bond sell-off and took some steam out of the USD rally.
USD can continue to benefit from widening US-G6 interest rate differentials. Still, tightening by other major central banks limits policy divergence with the Fed and suggests USD should struggle to sustain an overshoot of its June high. US economic growth outperformance and strong foreign appetite for US securities partly offsets that upside constraint for USD.
In the twelve months to July, foreign investors accumulated $1754bn of long-term US securities (treasury bonds & notes, corporate bonds, equities, gov’t agency bonds), more than twice the -$743bn US trade deficit. That points to solid underlying demand for USD.
JAPAN
USD/JPY dropped back below its 200-day moving average (158.47) on political jawboning. Japan’s Finance Minister Satsuki Katayama said US President Donald Trump raised concerns about yen weakness and Japanese Prime Minister Sanae Takaichi called the undervalued yen an issue.
Wide US-Japan yield gap (Fed funds rate at 3.75%-4.00% vs. BOJ at 1.25%) and the BOJ’s cautious tightening cycle keeps USD/JPY supported. But ongoing risk of official intervention to strengthen JPY and Japan’s favorable currency mix of loose fiscal/tight monetary policy are key headwinds for USD/JPY.
Bottom line: we expect USD/JPY to trade within a 155.00-160.00 range in the near term.
MEXICO
As was widely expected, Mexico’s central bank (Banxico) decided unanimously to keep the policy rate unchanged at 6.50% for a third straight meeting yesterday. Banxico scrapped its previous guidance to keep the policy rate at 6.50% but cautioned it need not match the Fed’s expected rate increases.
That suggests the bar for a hike remains high as long as Mexico inflation tracks the bank’s forecast. The swaps curve implies nearly 125bps of tightening in the next twelve months. Regardless, Mexico’s positive real yields, favorable balance of payments backdrop and energy exposure more than offsets the drag to MXN from less negative US-Mexico rate differentials.
