Date: 24 Jul 2018

President Trump’s lack of enthusiasm for Fed rate hikes and speculation that any policy changes by the Bank of Japan on July 31 might be in the direction of less loose Japanese monetary policy (even if the BoJ argues any such measures are to increase the BoJ’s flexibility in its monetary policy approach) could account for the recent steepening of the US yield curve, with long end rates rising more than the short end. After all the Fed exercises greater influence over the short end of the yield curve while the possibility of Japanese investors potentially moving money out of US Treasuries and back to Japan could account for lower UST prices and higher yields at the long end.  Traders will note that some of the speculation about possible BoJ intentions relates to the Japanese central bank’s policy of Yield Curve Control (YCC) and specifically its capping of 10-year Japanese Government Bond yields at 0.1 per cent. The question for the currency markets is whether such arguments are plausible and whether, if they are, they would have an impact on USDJPY.  If traders find these arguments persuasive it might logically suggest yen strength versus the USD. But do the arguments stack up? First off, if the Federal Reserve appeared to back off from raising US rate hikes in the face of Trump’s implied criticism, it would be disastrous for the Fed’s reputation as an independent central bank. In reality Trump’s comment probably makes the next Fed hike even more certain, in which case short end US rates should regain their poise. As for Japan, such has been the scale of BoJ asset purchases in recent years that there’s a persuasive argument that the Japanese central bank might wish to change tack as it’s running into implementation constraints. But that doesn’t necessarily mean the BoJ is moving to a less loose monetary policy, particularly in a circumstance where there’s talk the BoJ might be poised to downgrade its inflation expectations. As discussed in Monday’s piece, there might be good reasons why traders could foresee a lower USDJPY. But traders might wish to be cautious about co-opting recent moves in the US Treasury market to support that USDJPY view.

by Neal Kimberley, External Currency Analyst.