CAD JPY - FUNDAMENTAL DRIVERS
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The BoC delivered on expectations with a 50bsp hike as well as announcing a start to passive QT from the end of April by ending its reinvestment of maturing bonds. The bank upgraded both inflation and growth estimates as markets were expecting but did play a hawkish card by also increasing their neutral rate estimate to 2.5% from 2.25%. They acknowledged the growing risks from the current geopolitical situation but made it very clear that they are concerned about inflation and their hike of 50bsp showed that they think that policy needs to be normalized quickly (which some took as a hint that another 50bsp is on the way). The bank didn’t offer any additional clarity on QT but did note that they are not considering active QT of selling bonds just yet. Some conditionality also surfaced, where they explained that any sudden negative shocks to growth or inflation could see them pause hikes once they get closer towards neutral ( Gov Macklem also added that they might need to get rates slightly above neutral in the current cycle). Overall, it was a more hawkish than expected BoC decision, but interesting to note that STIR markets did not price in another 50bsp following the meeting (only a 25bsp) hike. We remain of the opinion that we are close to peak hawkishness for the BoC and are looking for the last push higher in the CAD for opportunities to sell.
2. Intermarket Analysis
Oil’s impressive post-covid recovery has been driven by many factors such as supply & demand , global demand recovery, and more recently geopolitical concerns. At current prices the risk to demand destruction and stagflation is high, which means we remain cautious of oil in the med-term . Reason for caution: Synchronised policy tightening targeting demand, slowing growth, consensus longs, steep backwardation curve, heightened implied volatility . We remain cautious oil , but geopolitics are a key driver and focus for Petro-currencies like the CAD (even though the CAD-Oil correlation has been hit and miss).
Global Risk Outlook
As a high-beta currency, the CAD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the CAD.
3. CFTC Analysis
Positioning was more mixed last week for the CAD, but we continue to think that markets are setting up a similar path compared to April 2021, Oct 2021 and Jan 2022 where markets were too aggressive to price in CAD upside only to see majority of it unwind later. As always though, timing those shorts will be very important.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
The BoJ kept all policy settings unchanged at their April meeting, which was in line with broad consensus expectations, but given the price action after the event did imply that a sizeable chunk of the market was expecting something more (us included). Due to the JPY weakness in recent weeks, markets wanted to see whether the bank would potentially increase their Yield Curve Control target band from 0.25%--0.25% to 0.50%--0.50%. But the bank decided to stick to their guns and maintain their ultra-easy policy despite the rapid depreciation of the JPY. The bank doubled down by saying they will conduct special open market operations on every working day as needed to keep the 10-year GBP capped at 0.25%. As expected, the bank reiterated their view that rates will stay low for the foreseeable future and won’t hesitate to add stimulus if the economy needs it. On the JPY, Gov Kuroda made familiar comments by saying they desire stable currency moves which reflect economic fundamentals. As a result of the bank’s inaction, all eyes will now be on the MoF to intervene if the rapid depreciation of the JPY continues.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite has soured. Even though that doesn’t change our med-term bias for the JPY, it does mean we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive and targeting demand, we expect U10Y to push lower in weeks ahead (especially as inflation tops out). If that happens there could be mild upside risks for the JPY if US10Y corrects, but we shouldn’t look at that in isolation and also weigh it alongside risk sentiment and demand for the USD.
4. CFTC Analysis
Another bullish signal from JPY positioning as net-shorts decreased across all three participants once again. With aggregate JPY positioning close to 2 standard deviationsfrom its 15-year mean, the risk to reward to chase the JPY lower from here is not very attractive. Last week saw some additional correction in JPY pairs, but without a more substantial reason for US10Y to push lower the attractiveness to buy the JPY is limited as well.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The BoC delivered on expectations with a 50bsp hike as well as announcing a start to passive QT from the end of April by ending its reinvestment of maturing bonds. The bank upgraded both inflation and growth estimates as markets were expecting but did play a hawkish card by also increasing their neutral rate estimate to 2.5% from 2.25%. They acknowledged the growing risks from the current geopolitical situation but made it very clear that they are concerned about inflation and their hike of 50bsp showed that they think that policy needs to be normalized quickly (which some took as a hint that another 50bsp is on the way). The bank didn’t offer any additional clarity on QT but did note that they are not considering active QT of selling bonds just yet. Some conditionality also surfaced, where they explained that any sudden negative shocks to growth or inflation could see them pause hikes once they get closer towards neutral ( Gov Macklem also added that they might need to get rates slightly above neutral in the current cycle). Overall, it was a more hawkish than expected BoC decision, but interesting to note that STIR markets did not price in another 50bsp following the meeting (only a 25bsp) hike. We remain of the opinion that we are close to peak hawkishness for the BoC and are looking for the last push higher in the CAD for opportunities to sell.
2. Intermarket Analysis
Oil’s impressive post-covid recovery has been driven by many factors such as supply & demand , global demand recovery, and more recently geopolitical concerns. At current prices the risk to demand destruction and stagflation is high, which means we remain cautious of oil in the med-term . Reason for caution: Synchronised policy tightening targeting demand, slowing growth, consensus longs, steep backwardation curve, heightened implied volatility . We remain cautious oil , but geopolitics are a key driver and focus for Petro-currencies like the CAD (even though the CAD-Oil correlation has been hit and miss).
Global Risk Outlook
As a high-beta currency, the CAD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the CAD.
3. CFTC Analysis
Positioning was more mixed last week for the CAD, but we continue to think that markets are setting up a similar path compared to April 2021, Oct 2021 and Jan 2022 where markets were too aggressive to price in CAD upside only to see majority of it unwind later. As always though, timing those shorts will be very important.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
The BoJ kept all policy settings unchanged at their April meeting, which was in line with broad consensus expectations, but given the price action after the event did imply that a sizeable chunk of the market was expecting something more (us included). Due to the JPY weakness in recent weeks, markets wanted to see whether the bank would potentially increase their Yield Curve Control target band from 0.25%--0.25% to 0.50%--0.50%. But the bank decided to stick to their guns and maintain their ultra-easy policy despite the rapid depreciation of the JPY. The bank doubled down by saying they will conduct special open market operations on every working day as needed to keep the 10-year GBP capped at 0.25%. As expected, the bank reiterated their view that rates will stay low for the foreseeable future and won’t hesitate to add stimulus if the economy needs it. On the JPY, Gov Kuroda made familiar comments by saying they desire stable currency moves which reflect economic fundamentals. As a result of the bank’s inaction, all eyes will now be on the MoF to intervene if the rapid depreciation of the JPY continues.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite has soured. Even though that doesn’t change our med-term bias for the JPY, it does mean we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive and targeting demand, we expect U10Y to push lower in weeks ahead (especially as inflation tops out). If that happens there could be mild upside risks for the JPY if US10Y corrects, but we shouldn’t look at that in isolation and also weigh it alongside risk sentiment and demand for the USD.
4. CFTC Analysis
Another bullish signal from JPY positioning as net-shorts decreased across all three participants once again. With aggregate JPY positioning close to 2 standard deviationsfrom its 15-year mean, the risk to reward to chase the JPY lower from here is not very attractive. Last week saw some additional correction in JPY pairs, but without a more substantial reason for US10Y to push lower the attractiveness to buy the JPY is limited as well.
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