The sharp unwind of carry trades triggered by uncertainty over BOJ’s policy rate trajectory has entered an uneasy pause. Indeed, USD/JPY rebounded above 146 after Deputy Governor Uchida stated that the BOJ won’t raise rates when market is unstable, making clear that financial stability is part of its policy consideration. The Nikkei index has also rebounded about 11% from its low since Monday. That said, markets should refrain from bidding USD/JPY back above 150. Japan’s political environment has turned increasingly averse towards a weak JPY, and the BOJ remains concerned about any inflation pass throughs from the exchange rate.
Even as speculative unwinds look largely done, rising geopolitical tensions in the Middle East and Russia should be watched as it could bolster safe haven demand for CHF and JPY. Egypt’s aviation ministry instructed all airlines to avoid Iran airspace due to military drills, while Ukraine staged a surprise military incursion into Russia. We are cautious that further strength in CHF could trigger an unexpected policy reaction. Unlike the undervalued JPY, CHF is highly overvalued. Recent CHF gains have extended its overvaluation towards the Aug 2011 record high based on our DEER model, which subsequently prompted SNB to introduce a floor for EUR/CHF. Yesterday, Swissmem put out a public statement calling SNB to act quickly in response to the sudden rise in CHF that is threatening a vulnerable recovery for overseas sales. SNB has already cut rates twice this year, and there is scope for more cuts to cool CHF demand.
USD/CNH has seemingly become a beta play to USD/JPY, rising towards 7.20 yesterday but now easing back towards 7.15 in concert with USD/JPY. This underscores the same speculative positioning forces at play in the offshore RMB as the JPY. Meanwhile, the PBOC had raised its USD/CNY fixing marginally to the highest since November on Wednesday. The RMB mood has turned more positive even in the face of LPR and MLF rate cuts, and thus there is a lesser need for the fixing to anchor RMB stability than before. We now expect a gradual, calibrated convergence in the CNY fixing back towards the spot rate, which closed at around 7.17.
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