Monetary policy divergences make the best trades and the market is sniffing one out in USD/JPY.
The Fed appears to be on its way towards cutting rates just as the Bank of Japan raises them. The market is pricing in a 70% chance of a Fed cut in March or earlier while the market sees a small-but-growing chance of the Bank of Japan hiking over that time period, including a 20% chance of a hike at the December 19 meeting.
The drop today began after BOJ Governor Ueda spoke. You would think he’d have delivered something hawkish but said the BOJ:
- Will patiently continue monetary easing under YCC to support economic
activity, cycle of wage growth - We have not yet reached a situation in which we can achieve price
target sustainably and stably and with sufficient certainty
What the market might have latched onto was this:
- Challenging situation remains
- It’ll become even more challenging towards the end of this year and into early 2024
- BOJ has not made decision on which interest rate to target once we
end negative interest rate policy - Whether to keep interest rate at zero or move it up to 0.1%, and at
what pace short-term rates will be hiked after ending negative rate
policy, will depend on economic and financial developments at the
time
Those comments made it sound like a foregone conclusion.
At the same time, yen-shorts have been a monumentally crowded trade filled to structural positions. A rush out of those turned into a flood as USD/JPY fell through 144.00, leading to an air-pocket down to 141.73 — surely a sign of longs getting squeezed out.
The daily chart highlights the size of the one-day move, which stands around 400 pips.
The temptation here is to try to catch the falling knife. That’s rarely a good move but could be supported by a strong non-farm payrolls report tomorrow and some push-back next week on Fed rate cuts in Q1.
Another spot people are carefully watching is the US dollar side. The inflation picture continues to improve and one-year breakevens are now below 2%. A big part of that is the collapse in oil prices and growing expectation that we’re headed towards another breakdown in OPEC that will see crude flood into the market to try and halt US production growth.