They Think It’s All Over
Views are my own. Just my thoughts on macro developments. Not investment advice.
Just as markets felt fully checked out for the year the BOJ have sent a shock to lightly staffed trading desks across the globe.
The BOJ have widened the band that the 10yr JGB yield can trade in around 0% from 25bps to 50bps. Given that the pressure is for higher yields in G10 this band is essentially a cap as the 10yr JGB yield is constantly testing the top of this band. So a widening of the band may seem like a mere adjustment but effectively it lifts the 10-yr JGB yield from 25bps to 50bps.
BOJ’s Kuroda is adamant that today’s “adjustment” is NOT a hike or a signal of a potential end to YCC. Although in my opinion what is important is that the yield on the 10yr JGB just doubled from 25bps to 50bps. So that feels like a hike. I also feel that this sends a very strong signal. The trade of this year has been to sell JPY against anything as the BOJ were unwavering in their commitment to extremely loose monetary policy. This rate divergence is what drove USDJPY 15% higher this year. The possibility of hawkish surprises from the BOJ have now been introduced and the markets probability distributions will need to be adjusted accordingly. The news articles out yesterday and last week about a possible policy review next year or added flexibility to the 2% inflation goal now feel like they were a signal of what was to come https://blinks.bloomberg.com/news/stories/RN4EZET0G1KW
Liquidity is already poor in the week leading up to Christmas. The market will be loathe to put on fresh risk and market makers will be reluctant to take much risk on. Given that selling JPY (buying crossJPY) has been THE trade of 2022 I expect there is a lot of positioning to potentially be unwound. I therefore feel this move lower in crossJPY could have legs. I like being long JPY into the new year, whether this was a policy adjustment or not.
Also a quick note on the ECB. They have been resolutely hawkish. The ECB have reminded the market that tackling inflation is going to be a long and painful process and that tightening has a lot further to go. As I have noted before, the ECB and BOE are in a tough spot. Their economies are crippled by an energy crisis, their consumers are buckling under the weight of the biggest cost of living crisis in a generation but they have to keep tightening policy to fight inflation. This is not a bullish outcome for their currencies in my view, not against safe haven USD. Particularly for the ECB where they have the delicate balancing act of periphery yields. This is why EURUSD topped out at 1.0737 and has since turned lower. Curve inversion shows the markets concern about a sharp recession. All of this also adds to my view that next year could be an awful one for risk assets. I am expecting a stagflation scenario next year where central banks are forced to remain hawkish even as the global economy plummets into recession as inflation stays sticky. That’s a bullish environment for USD so I am sticking to USD longs for 2023.
Worth noting that according to a BofA Global Fund Manager Survey the market is the most bearish on USD since May 2006. Just as the market thought the year was over they also think the USD trend higher is over. I am expecting the unexpected for 2023.
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