Comfortably Numb

May 02, 2024

Comfortably Numb

  • The Fed is in no rush to cut rates and leaned against rate hike expectations.
  • BOJ intervenes for a second time this week.
  • Inflation in Switzerland overshoots expectations but remains well below 2%.

USD/JPY dropped sharply by 4.5 big figures to near 153.00 yesterday evening on suspected MOF/BOJ intervention. USD/JPY has bounced-back towards 156.00 this morning. Japan’s government will disclose any intervention at end of May. Regardless, the price action indicates the BOJ stepped-in to the tune of roughly ¥5 trillion. The latest report on the changes in current account balances at the BOJ suggests the amount behind Monday’s likely intervention was around ¥5.5 trillion when USD/JPY traded in a 5.6 yen range.

The Bank of Japan’s (BOJ) March meeting minutes further highlights that policymakers don’t have appetite to tighten aggressively. According to the minutes, “some members pointed out that…changes in the monetary policy framework would not be a shift to a phase of monetary tightening, which was the case in the United States and Europe”. Moreover, “some members expressed the view that it was important for the Bank to provide clear and thorough communication so that there would not be a spread in the misunderstanding that it had shifted its monetary policy stance from monetary easing to rapid policy interest rate hikes”.

The BOJ March meeting minutes also noted that the yen's value had deviated notably from purchasing power parity. Indeed, we estimate long-term fundamental equilibrium for USD/JPY at 95.00, implying a 60% overvaluation relative to the current spot rate. However, USD/JPY overvaluation is justified by wide US-Japan real long-term interest rate differentials.

USD fell and Treasuries rallied after the FOMC interest rate decision because the Fed pushed back against rate hike expectations. The Fed delivered a neutral hold. The Fed kept the target range for the funds rate at 5.25-5.50% (widely anticipated) and reiterated it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent”. As Fed Chair Jay Powell pointed out in his opening statement “so far this year, the data have not given us that greater confidence”.

Fed Chair Jay Powell’s comments were not as hawkish as anticipated. Powell emphasised “I think it’s unlikely that the next policy rate move will be a hike”. Instead, Powell highlighted paths that would cause the Fed to want to consider rate cuts. According to Powell “two of those paths would be that we do gain greater confidence…[that] inflation is moving sustainably down to 2%...Another path could be an unexpected weakening in the labor market”.

The Fed also confirmed plans to begin slowing the pace of its balance sheet runoff on June 1. In line with expectations, the monthly redemption cap on Treasury bonds will slow to US$25bn from currently US$60bn. The cap on monthly agency debt and agency mortgage-backed securities (MBS) redemptions stays US$35bn any principal payments in excess of this cap will be reinvested into Treasury securities. Slowing down the pace of balance sheet reduction reduces the probability that money markets experience undue stress and has no implications for the stance of monetary policy.

The US productivity report is today’s highlight (1:30pm London). Productivity (GDP/hours worked) is expected to increase 0.5% q/q/ in Q1 vs. 3.3% in Q4. Importantly, annual productivity growth has improved significantly in the last year and is running above its post-war average of 2.1%. Rising productivity leads to low inflationary economic growth which translates to higher real interest rate and an appreciation in the currency over the longer term.

We also get more US jobs data ahead of tomorrow’s April nonfarm payrolls report with the April Challenger job cuts (12:30pm London) and weekly jobless claims (1:30pm London). This week’s April ADP employment and March JOLTS reports showed that labor demand is still strong but cooling. Overall, we are sticking to our view that the cyclical USD uptrend is intact underpinned by the encouraging US macroeconomic backdrop.

CHF rallied across the board after inflation in Switzerland overshoots expectations. Headline CPI inflation quickened from 1.0% in March to 1.4% y/y in April (consensus: 1.1% y/y). Core CPI inflation rose to 1.2% y/y (consensus: 0.9%) from 1.0% in March. The swaps market trimmed the probability of 2 cuts by March 2025 to 80%.

AUD/USD and NZD/USD are higher on Fed-driven positive risk sentiment. In Australia, the number of dwellings approved rose less than expected by 1.9% m/m in March (consensus: +3.4%) following a 0.9% decline in February. The bigger picture shows building approvals remains in a firm downtrend which will further constrain the supply of new dwellings and push house prices higher.

In New Zealand, the number of new dwellings consented dipped 0.2% in March after rising 15.9 m/m in February. On an annual basis, the number of homes consented is down 25% suggesting residential investment will remain a drag to NZ growth.

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