GBP
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The outlook for the UK economy remains bleak, with CPI above 10% and recession expecting to hit in 4Q22 and last for 5 quarters, it has kept pressure on Sterling despite ongoing BoE rate hikes. Even though the bank followed through with a 50bsp hike in July, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, and some participants calling for as high as 18% by next year (due to the rapid rise in energy prices) the bank is stuck between a rock and a hard place as they are forced to keep hiking rates to try and fight inflation but by doing so, they risk further damaging economic growth as a result. The post-BoE price action in Sterling did not reflect a market that was pricing in a 5-quarter recession in the UK, and the price action we saw in the past two weeks made a lot of sense with Sterling catching up to the downside to reflect the growth situation. Even though the bias remains titled lower, a lot of bad news has once again been priced in for the Pound in a relatively short space of time, and with positioning continuing to give bullish signals, chasing lower seems like a bit of a risk right now.
POSSIBLE BULLISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. With a recession now the base assumption, any incoming data that surprises meaningfully higher could trigger some relief. With focus on stagflation, any downside surprises in CPI or factors that decrease inflation pressures are expected to support the GBP and not pressure it. The economy needs help, which means any help from the fiscal side will be a positive. Any major fiscal support measures from the incoming PM to help consumers (subsidies or tax cuts) could trigger bullish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any major de-escalation can see some upside for Sterling.
POSSIBLE BEARISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. Even with recession now the base assumption, any material downside surprises in growth data can trigger further downside. With focus on stagflation, any upside surprises in CPI or factors that increase more inflation pressures are expected to weigh on the GBP and not support it. The economy needs help, which means any help from the fiscal side should be a positive, but any fiscal measures from the incoming PM that could exacerbate inflation pressures could trigger bearish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
BIGGER PICTURE
The fundamental outlook for the GBP remains bleak, especially after the BoE’s recent forecasts of a 5-quarter recession in the UK. Furthermore, given the risks to growth, there is growing speculation that the BoE might not be too far away from pausing their current hiking cycle. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure could see some reprieve since the currency is trading at fresh new cycle lows. Even though the bias remains bleak, there is a lot of bad news priced for Sterling, so choose your trades carefully.
JPY
FUNDAMENTAL OUTLOOK: BEARISH
BASELINE
In recent weeks, yield differentials have been the biggest negative driver for the JPY with the BoJ keeping 10-year JGB yields capped at 0.25% with yield curve control while other central banks are hiking rates aggressively. Thus, the BoJ’s reluctance to shift on policy even with inflation starting to push higher remains a negative driver for the JPY. Even though the JPY is considered a safe haven, inflows has been limited in the current bear market compared to other cycles. The reason is Japan’s current account surplus (a main reason for safe haven appeal) has deteriorated due to the rise in commodity prices. Japan imports the bulk of their commodities, so very high energy prices has added to downside. The BoJ and MoF’s reluctance to intervene to stop the rapid depreciation in the JPY in recent weeks has been noticeable. As long as they just voice their dislike but fail to act, the market will keep testing them. Having said that, US10Y and commodities have been reacting more and more negative to the current negative cyclical growth outlook, and as a result has seen big players trim their massive JPY shorts. But this past week’s push higher in yields was a friendly reminder that inflation and yield differentials remain a major downside risk for the JPY, despite the negative cyclical outlook.
POSSIBLE BULLISH SURPRISES
Catalyst that triggers speculation that the BoJ could drop YCC or hike rates or both (big upside surprises in inflation) could trigger upside in JPY, which means inflation data will be important to keep on the radar. Catalysts that trigger meaningful corrections in US10Y (less hawkish Fed, faster deceleration in US inflation, faster deceleration in US growth) or meaningful bouts of risk off sentiment could trigger bullish reactions from the JPY. Any catalyst that triggers meaningful downside in key commodities like Oil (deteriorating demand outlook, ease in supply shortage) could trigger bullish JPY reactions. Any intervention from the BoJ or MoF to stop JPY depreciation (buying the JPY or giving firm and clear lines in the sand for USDJPY) could offer decent reprieve for the JPY.
POSSIBLE BEARISH SURPRISES
With yield differentials playing such a huge role for the JPY, any catalysts that push US10Y higher (more aggressive Fed, further acceleration in US inflation, better-than-expected US growth data) could trigger further bearish price action for the JPY. Any catalyst that creates further upside in oil prices (further supply concerns, geopolitical tensions) poses downside risks for Japan’s current account surplus and could trigger further bearish reactions in the JPY. Further reluctance from the BoJ and MoF to address the concerning depreciation in the JPY, and further reluctance from the BoJ to pivot away from very dovish policy is a continued negative driver for the JPY to keep on the radar. If the BoJ pushes back against calls for a policy shift despite upside surprise in CPI could trigger further JPY downside.
BIGGER PICTURE
The fundamental outlook remains bearish for the JPY, especially after the BoJ once again stuck to the same overly dovish script at their July meeting. As long as US10Y remain elevated and the BoJ stays stubbornly dovish and no push back is made against the JPY weakness from the BoJ or MoF, the bias remainslower. But take note of positioning which means we don’t want to chase the JPY lower and bullish reactions can see outsized upside on big drops in US10Y & commodities (which means keeping cyclical developments in the US in mind as a key influence on US10Y and thus the JPY as well). It also means watching incoming CPI data closely as any huge upside surprises could trigger speculation of a possible policy shift.
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The outlook for the UK economy remains bleak, with CPI above 10% and recession expecting to hit in 4Q22 and last for 5 quarters, it has kept pressure on Sterling despite ongoing BoE rate hikes. Even though the bank followed through with a 50bsp hike in July, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, and some participants calling for as high as 18% by next year (due to the rapid rise in energy prices) the bank is stuck between a rock and a hard place as they are forced to keep hiking rates to try and fight inflation but by doing so, they risk further damaging economic growth as a result. The post-BoE price action in Sterling did not reflect a market that was pricing in a 5-quarter recession in the UK, and the price action we saw in the past two weeks made a lot of sense with Sterling catching up to the downside to reflect the growth situation. Even though the bias remains titled lower, a lot of bad news has once again been priced in for the Pound in a relatively short space of time, and with positioning continuing to give bullish signals, chasing lower seems like a bit of a risk right now.
POSSIBLE BULLISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. With a recession now the base assumption, any incoming data that surprises meaningfully higher could trigger some relief. With focus on stagflation, any downside surprises in CPI or factors that decrease inflation pressures are expected to support the GBP and not pressure it. The economy needs help, which means any help from the fiscal side will be a positive. Any major fiscal support measures from the incoming PM to help consumers (subsidies or tax cuts) could trigger bullish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any major de-escalation can see some upside for Sterling.
POSSIBLE BEARISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. Even with recession now the base assumption, any material downside surprises in growth data can trigger further downside. With focus on stagflation, any upside surprises in CPI or factors that increase more inflation pressures are expected to weigh on the GBP and not support it. The economy needs help, which means any help from the fiscal side should be a positive, but any fiscal measures from the incoming PM that could exacerbate inflation pressures could trigger bearish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
BIGGER PICTURE
The fundamental outlook for the GBP remains bleak, especially after the BoE’s recent forecasts of a 5-quarter recession in the UK. Furthermore, given the risks to growth, there is growing speculation that the BoE might not be too far away from pausing their current hiking cycle. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure could see some reprieve since the currency is trading at fresh new cycle lows. Even though the bias remains bleak, there is a lot of bad news priced for Sterling, so choose your trades carefully.
JPY
FUNDAMENTAL OUTLOOK: BEARISH
BASELINE
In recent weeks, yield differentials have been the biggest negative driver for the JPY with the BoJ keeping 10-year JGB yields capped at 0.25% with yield curve control while other central banks are hiking rates aggressively. Thus, the BoJ’s reluctance to shift on policy even with inflation starting to push higher remains a negative driver for the JPY. Even though the JPY is considered a safe haven, inflows has been limited in the current bear market compared to other cycles. The reason is Japan’s current account surplus (a main reason for safe haven appeal) has deteriorated due to the rise in commodity prices. Japan imports the bulk of their commodities, so very high energy prices has added to downside. The BoJ and MoF’s reluctance to intervene to stop the rapid depreciation in the JPY in recent weeks has been noticeable. As long as they just voice their dislike but fail to act, the market will keep testing them. Having said that, US10Y and commodities have been reacting more and more negative to the current negative cyclical growth outlook, and as a result has seen big players trim their massive JPY shorts. But this past week’s push higher in yields was a friendly reminder that inflation and yield differentials remain a major downside risk for the JPY, despite the negative cyclical outlook.
POSSIBLE BULLISH SURPRISES
Catalyst that triggers speculation that the BoJ could drop YCC or hike rates or both (big upside surprises in inflation) could trigger upside in JPY, which means inflation data will be important to keep on the radar. Catalysts that trigger meaningful corrections in US10Y (less hawkish Fed, faster deceleration in US inflation, faster deceleration in US growth) or meaningful bouts of risk off sentiment could trigger bullish reactions from the JPY. Any catalyst that triggers meaningful downside in key commodities like Oil (deteriorating demand outlook, ease in supply shortage) could trigger bullish JPY reactions. Any intervention from the BoJ or MoF to stop JPY depreciation (buying the JPY or giving firm and clear lines in the sand for USDJPY) could offer decent reprieve for the JPY.
POSSIBLE BEARISH SURPRISES
With yield differentials playing such a huge role for the JPY, any catalysts that push US10Y higher (more aggressive Fed, further acceleration in US inflation, better-than-expected US growth data) could trigger further bearish price action for the JPY. Any catalyst that creates further upside in oil prices (further supply concerns, geopolitical tensions) poses downside risks for Japan’s current account surplus and could trigger further bearish reactions in the JPY. Further reluctance from the BoJ and MoF to address the concerning depreciation in the JPY, and further reluctance from the BoJ to pivot away from very dovish policy is a continued negative driver for the JPY to keep on the radar. If the BoJ pushes back against calls for a policy shift despite upside surprise in CPI could trigger further JPY downside.
BIGGER PICTURE
The fundamental outlook remains bearish for the JPY, especially after the BoJ once again stuck to the same overly dovish script at their July meeting. As long as US10Y remain elevated and the BoJ stays stubbornly dovish and no push back is made against the JPY weakness from the BoJ or MoF, the bias remainslower. But take note of positioning which means we don’t want to chase the JPY lower and bullish reactions can see outsized upside on big drops in US10Y & commodities (which means keeping cyclical developments in the US in mind as a key influence on US10Y and thus the JPY as well). It also means watching incoming CPI data closely as any huge upside surprises could trigger speculation of a possible policy shift.