Currency carry trades are reversing on the back of falling short-end US yields, and increased risk aversion stemming from a tech sell-off. Lower-yielding JPY and RMB have rebounded against the USD, even as the USD has broadly held steady or strengthened against higher-yielding currencies such as NZD. US Q2 GDP today could reinforce expectations of a Fed rate cut in September, and potentially provide another lift for the low yielders.
USD/JPY has fallen towards 153, weighed by an unwind of carry trades amid large speculative short positioning. We had warned at the start of July that USD/JPY was too elevated and vulnerable to a reversal from tail risks (see here). Since then, a combination of JPY buying intervention, increased pricing of Fed rate cuts, pushback against a weak JPY by Trump and Japanese politicians, as well as US equity sell-offs have all contributed to a sharp reversal of the JPY, catapulting JPY to become the best performing currency in G10 and Asia on a quarter-to-date basis. JPY is also being supported by the fact that Japanese monetary policy is set to tighten further, in contrast to coming rate cuts by the Fed and ECB. Media reports yesterday indicate that the BOJ is weighing a rate hike in its policy meeting next week, on top of a halving of its JGB purchases that will be done gradually. The JPY recovery could continue if the BOJ holds a more optimistic policy outlook.
USD/CNH has eased towards 7.26 as it belatedly catches down with USD/JPY, and is now lower that the pre-LPR cut level. While the timing of PBOC’s rate cut on Monday was a surprise, a rate cut was not unexpected by markets, and the impact on RMB has thus been small and outweighed by global developments. Meanwhile, the onshore USD/CNY fixing has crept higher to mid-7.13 levels post the Third Plenum but is by and large stable. Further reform details from the Third Plenum have also emerged. Fiscal reforms to support the tax base of local governments is a notable one that underpins LGFV debt stability.
USD/CAD bounced above 1.38, after the BOC cut rates by 25bps yesterday to 4.50%. Markets had priced in an 85% chance of a rate cut, and CAD weakness had been muted. Governor Macklem said that with the inflation target in sight, downside risks are taking on increased weight in the BOC’s monetary policy deliberations.
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