Dollar Steadies as Markets Digest BOJ Shocker

December 21, 2022
  • The BOJ’s surprise move has helped push global yields higher; is the carry trade dead?; markets are still fighting the Fed; housing data are likely to show continued weakness; Canada reports November CPI
  • Germany reported January GfK consumer confidence; unlike the Fed, the market seems to believe the ECB; U.K. fiscal trajectory is deteriorating; Czech National Bank is expected to keep rates steady at 7.0%
  • Japan has already seen tighter financial conditions as yields rose and the yen gained; WIRP suggests a rate hike could come as soon as the March 9-10 meeting; markets are inching closer to a test of the new trading band; Korea reported weak trade data for the first twenty days of December

The dollar has steadied as markets continue to digest the BOJ’s surprise move. The yen is trading flat near 131.80 after trading as low as 130.60 yesterday. Break below the August low near 130.40 would set up a test of the May low near 126.35. DXY is trading modestly higher near 104.11 after trading as low as 103.78 yesterday. The euro is trading lower near $1.06, while sterling is lagging again and trading lower just below $1.21. EM FX is mostly lower and should come under further pressure as global liquidity tightens further. We continue to believe that the fundamental outlook still favors the dollar but the BOJ has thrown a spanner in the works. We remain negative on the euro and sterling but our 2023 forecasts for USD/JPY will have to be marked lower as the timetable for BOJ liftoff has been moved forward (see below).


The Bank of Japan’s surprise move has helped push global yields higher. We believe this is due to a variety of channels. First off, the BOJ capitulation underscores that the era of low interest rates is officially over, the final nail in the coffin so to speak. The policy pivot also means that Japanese investors will finally see greater positive yields domestically, which means they won’t have to continue chasing yields all around the world. As it is, Japan investors have been unloading foreign bonds at a fairly rapid clip in recent months and we expect that to continue. Without a strong bid from Japan, yields are likely to continue rising in the rest of the world. That is of course negative for peripheral eurozone and EM debt, as well as the U.S.

Is the carry trade dead? We don't want to belabor the point but decades of low domestic yields helped push Japan investors into EM FX and debt, peripheral eurozone debt, and other areas that are way out on the credit curve. If this week’s move is the first step towards tightening (which we think it is), this will likely usher in a new period of a strong yen. As a result, the yen may no longer be the currency of choice for the carry trade. Indeed, with more inward-looking Japanese investing likely to be seen, we suspect we will see weaker demand for the higher yielding currencies (both majors and EM) that make up the other leg of the carry trade.

Markets are still fighting the Fed. After rising as high as 5.5% after the meeting, the terminal rate as seen by the swaps market fell back to just below 5.0%. Similarly, WIRP suggests a 50 bp hike February 1 is only 30% priced in, followed by a final 25 bp hike either March 22 or May 3. We cannot understand why the markets continue to fight the Fed. With the exception of some communications missteps here and there, Powell and company have been resolute about the need to take rates higher for longer. The Dot Plots couldn’t be any clear that rates will be kept high and yet the market continues to price in an easing cycle for H2 2023. Although the media embargo has been lifted, there are no Fed speakers scheduled this week.

Housing data are likely to show continued weakness. Yesterday, November building permits came in at -11.2% vs. -2.1% expected while housing starts came in at -0.5% m/m vs. -1.8% expected. Both y/y rates fell to new cycle lows. Existing home sales (-5.2% m/m expected) will be reported tomorrow and new home sales (-5.1% m/m expected) will be reported Friday. On Monday, December NAHB housing market index came in at 31 vs. 34 expected and 33 in November and was the lowest since April 2020. This suggests little relief ahead for this beleaguered sector. Q3 current account data (-$222.0 bln expected) and December Conference Board consumer confidence (101.0 expected) will be reported.

Canada reports November CPI. Headline is expected at 6.7% y/y vs. 6.9% in October. If so, this would be the lowest since February and would continue the deceleration from the 8.1% peak in June. Yesterday, October retail sales came in firm as headline rose 1.4% m/m and ex-autos rose 1.7% m/m. October GDP will be reported Friday. Bank of Canada tightening expectations remain subdued. WIPR suggests odds of a 25 bp hike January 25 are only around 50%, which is consistent with swaps market pricing in a peak policy rate between 4.25-4.5% vs. 4.25% currently.


Germany reported January GfK consumer confidence. It came in at -37.8 vs. -38.0 expected and a revised -40.1 (was -40.2) in December. This comes after better than expected IFO business sentiment was reported earlier this week. Improved eurozone readings have come against a backdrop of relatively warm weather and lower energy prices. Recent developments, if sustained, will surely challenge this more optimistic outlook and we believe expectations (both official and markets) for a short and shallow recession are likely to prove too optimistic.

Unlike the Fed, the market seems to believe the ECB. The swaps market is now pricing in a peak policy rate between 3.75-4.0% vs. 3.0% at the start of last week. Elsewhere, WIRP suggests a 50 bp hike February 2 is priced in, with no odds of a larger 75 bp move. Another 50 bp hike is about 75% priced in for March 16. Can the ECB really double the current 2% deposit rate even as the eurozone goes into recession? If it does, then the recession will be anything but short and shallow. This market pricing strikes us as too aggressive and yet the euro has hardly benefitted from this more hawkish outlook.

The U.K. fiscal trajectory is deteriorating. November public sector net borrowing was reported. Total PSNB came in at GBP21.2 bln vs. GBP14.5 bln expected and a revised GBP13.4 bln (was GBP12.7 bln), while PSNB ex-banking groups came in at GBP22.0 bln vs. GBP14.8 bln expected and a revised GBP14.2 bln (was GDP13.5 bln) in October. Of note, total PSNB for the first eight months of the current FY rose to GBP105 bln and the Office for Budget Responsibility forecasts the full FY total at GBP177 bln. The data illustrate just how little room there is for Chancellor Hunt in terms of fiscal policy as energy subsidies and rising borrowing costs take a mounting toll on public finances. Despite more and more strikes planned, he has no choice but to continue on the austerity path as the U.K. seeks to regain the credibility lost by the Truss/Kwarteng tax plan.

Bank of England tightening expectations remain subdued after last week’s dovish message. WIRP suggests a 50 bp hike February 2 is about 75% priced in, with no odds of a larger 75 bp hike. The swaps market back to pricing in a peak policy rate near 4.75% vs. 4.5% right after last week’s BOE decision but still down sharply from 6.25% right after the mini-budget in late September. Of note, the CBI released its December distributive trades survey. Retailing reported sales came in at 11 vs. -24 expected and -19 in November, while total reported sales came in at -5 vs. -24 in November.

Czech National Bank is expected to keep rates steady at 7.0%. At the last policy meeting November 3, the bank left rates unchanged at 7.0%, as expected. Two dissents favored a 75 bp hike but were easily outvoted by the five does. The bank said rates were at a level that is taming demand pressures and that rates would remain “relatively” high for some time. Governor Michl said then the next move would be no change or a hike. The swaps market is pricing in the start of an easing cycle over the next three months, which seems too soon given how high inflation remains.


Japan has already seen tighter financial conditions as yields rose and the yen gained. Policymakers knew this would happen and went ahead and tweaked YCC anyway. At what point does the strong yen become too strong? USD/JPY started this year off around 115 and traded as high as 152 back on October 21. BOJ intervention and the notion of a Fed pivot drove the pair down to around 130 before recovering to around 135. Now, all bets are off as markets rightfully price in a BOJ hike in 2023. The August low for USD/JPY near 130.40 is a foregone conclusion. After that is the May low near 126.35. After that is the March 31 low near 121.30 but let's get to 125 first and then we can talk.

WIRP suggests a rate hike could come as soon as the March 9-10 meeting. Similarly, the swaps market is pricing in the start of a tightening cycle over the next six months, with the policy rate seen near 0.30% in one year and 0.50% in two years. Given the quickly evolving situation, we see upside risks. We believe the November national CPI data out this Friday have taken on great significance, as continued acceleration of inflation will likely move the timetable for BOJ liftoff forward.

Markets are inching closer to a test of the new trading band. JGB yields rose again today but the 10-year stopped at 0.47%, just shy of the new upper limit. However, yields at the longer end of the JGB curve have risen sharply in anticipation of further relaxation and eventual elimination of YCC. Of note, the 2-year JGB yield moved into positive territory for the first time since 2015 and helped push the global total of negative yielding debt down to around $686 mln, the lowest since 2015. The end of an era is upon us.

Korea reported weak trade data for the first twenty days of December. Exports came in at -8.8% y/y vs. -14.0% y/y in November, while imports came in at 1.9% y/y vs. 2.7% in November. Exports to China fell -26.6% y/y while exports to the U.S. rose 16.1% y/y. Chip exports fell -24.3% y/y. Regional trade data have weakened considerably in recent months, not just from the mainland slowdown but also from overall global slowing.

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