GBP JPY - FUNDAMENTAL DRIVERSGBP
FUNDAMENTAL BIAS: BULLISH
1. The Monetary Policy outlook for the BOE
The Sep policy meeting from the BoE saw money markets rushing to price in a much faster and more aggressive policy path than previously expected. Even though this of course falls in line with our bullish bias for the Pound, we do think the market is a bit too aggressive too quick right now. The bank did explain that they now see inflation above 4% by Q4 of this year, and the possibility of more sticky inflation was the key reasons why we saw a 7-2 QE vote split with Saunders and Ramsden both dissenting to cut purchases. However, it’s important to note that the remaining 7 members still see inflation as transitory, and the fact that they expect CPI above 4% means any prints that don’t come close to that poses downside risks. Furthermore, even though the bank said their expectations of modest tightening has strengthened, the admitted that lots of uncertainties remain. A big one of these is the labour market, where even though the number of furloughed staff have decreased, that decrease has materially slowed from August which poses more uncertainty for the labour market. Thus, even though our bias remains unchanged, and we see the bank lifting rates in Q1, we do think the over optimistic moves in money markets poses short-term headwinds.
2. The country’s economic developments
The successful vaccination program that allowed the UK to open up faster and sooner than peers & provided a favourable environment for Sterling and the strength of the economic recovery and GDP upgrades from the BOE and IMF meant growth differentials favoured GBP. However, a lot of these positives are arguably priced, and the recent slowdown in activity data that suggests peak growth has been reached could mean an uphill push for GBP to see the same size of outperformance we saw earlier. With our above comments about money markets, it also means that there is now more risk to downside surprises than was the case a few months ago.
3. Political Developments
Even though a Brexit deal was reached at the end of last year, some issues like the Northern Ireland protocol remains, and with neither side willing to budge right now it seems like a never ending can kicking could see these issues drag on for a long time. For now, Sterling has looked through all the rigmarole and should continue to do so as long as the cans are kicked down the road.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -5008 with a net non-commercial position of -218. The Pound pushed higher after last week’s FOMC failed to send jitters across risk assets and after the market got very optimistic about higher interest rates in the UK next year. However, as we noted above, we are cautious of recent money market pricing. Another factor to consider in the week ahead is the flurry of reports over the weekend of the current energy hick ups facing the UK, with some media outlets reporting massive fuel shortages which has sparked a frenzy of panic buying and possibly creating a much bigger issue than there was originally. Even though the government has assured that there is enough fuel and currently no crisis, we do want to keep the risks of some possible negative sentiment for GBP in line with this in mind.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is the primary driver of JPY. Economic data rarely proves market moving; and although monetary policy expectations can prove highly market-moving in the short-term, safe-haven flows are typically the more dominant factor. The market's overall risk tone has improved considerably following the pandemic with good news about successful vaccinations, and ongoing monetary and fiscal policy support paved the way for markets to expect a robust global economic recovery. Of course, there remains many uncertainties and many countries are continuing to fight virus waves, but as a whole the outlook has kept on improving over the past couple of months, which would expect safe-haven demand to diminish and result in a bearish outlook for the JPY.
2. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares an inverse correlation to strong moves in yield differentials, more specifically in strong moves in US10Y. However, like most correlations, the strength of the inverse correlation between the JPY and US10Y is not perfect and will ebb and flow depending on the type of market environment from a risk and cycle point of view. The rangebound price action in US10Y from July saw our conviction for more upside in USDJPY take a knock, and we have been waiting for US10Y to make a more sustainable break before we look to add longs in USDJPY. This week, we finally saw US10Y being able to clear the key 1.38% level that has acted as strong resistance since July. Thus, as long as US10Y manages to stay above 1.38% we would look for pull backs in USDJPY to look for med-term buy opportunities. However, since 1.38% was such a key level, any break and close below 1.38% for the US10Y would be an automatic trigger to reduce any exposure.
3. CFTC Analysis
Latest CFTC data showed a positioning change of +4224 with a net non-commercial position of -56071. With positioning still well inside netshort territory we want to be careful of the risks going in September which is historically the worse performing month for equities. That alone doesn’t mean we are expecting equities to push lower but given the frothy price action over recent weeks, as well as seasonality, as well as the growing chorus of participants calling for a bigger correction, as well as the Evergrande debacle, we don’t want to ignore the possibility of some increased volatility. That doesn’t mean we start buying the JPY of course, it just means that if we do see some jitters creeping in for risk assets it is expected to be positive for the JPY, and with a big net-short there is a lot of downside in the JPY that can be unwound in such a scenario.
