Yen Rise Supported By Guesstimates

Tuesday July 26: Five things the markets are talking about.

Market volatility is picking up ahead of the Federal Open Market Committee (FOMC) and Bank of Japan (BoJ) decisions later this week. In overnight trading, Australasia markets were especially unsettled with more headlines pertaining to the fiscal/monetary stimulus mix from the BoJ.

In Europe, that apprehension is not being lost on investors, as they too are expecting lots of results this week – it’s the biggest week for the European market in a long while. They are also waiting for the Euro financial stress test results on Friday before going into the banking sector, and comments after the different policy meetings to get a sense of what central banks will or won’t do.

The Fed begins its two-day policy meeting today. Investors are not expecting any changes to their monetary policy decision Wednesday, but the statement language will be watched closely for hints on the future path for rate increases.

To date, investors have become more optimistic about the prospect of rate increases lately, with markets now pricing in a +51% chance of an increase by the Fed’s December meeting and its these rate differentials that are helping to support the dollar.

1. Concern that Japan monetary and fiscal easing will disappoint expectations

The yen’s rise this year has complicated Japan’s efforts to boost economic growth by weighing on inflation and making Japanese exports less competitive globally. Again last night, yen was the markets primary focus as investors sharply scaled back their expectations for Japan’s soon-to-be announced stimulus package, sinking equities and supporting the yen.

A Nikkei report before the market opened speculated that PM Abe’s government would double the “planned” extra spending for 2016 in their stimulus package to +¥6T. Despite this number being possibly doubled, the market had been pricing in a much bigger number, anything from +¥10-20T was being mentioned as of last Friday. Also disappointing traders was the fact that the spending will come over several years, which means the initial impact will be less than hoped.

Japan’s Finance Minister Aso later stated that the size of economic stimulus is not yet decided and monetary policy is in BoJ’s hands – theses comments have helped send the yen to test the psychological ¥104 handle ahead of the U.S open.

It seems that the market is not confident that the BoJ’s Kuroda will pull the trigger this Friday.

2. BoE’s Weale changes tune and moves to “dovish” camp

BoE rate setter Martin Weale (former ‘hawk’) has signalled he will now vote in favour of providing fresh stimulus (Aug 4th) for the U.K. economy, a change of stance prompted by last Friday’s U.K PMI’s that pointed to a decline in economic activity since the historic June 23 Brexit vote.

It was only two week’s ago that Weale indicated that he was not convinced that a cut to the BoE’s key interest rate was needed in the wake of the vote. His change of heart leaves only “one” MPC member expressing reluctance to vote for more stimulus in a couple of weeks.

Sterling immediately dropped to a new two-week low of £1.3058 and a one-week low of €0.8428. From a technical perspective, strong support for the pound remains around the £1.30 handle – however, investors should expect further renewed selling ahead of the BoE decision.

Thus far, traders expect QE to be the MPC’s preferred policy tool in terms of delivering a more potent package – initial guesstimates are around £50B, however, anything bigger could see the pound quickly revisit its Brexit lows £1.2796.

3. Global indices send out mixed messages

A rebound in European equities has lost steam after reaching a one-month high last week.

This morning, Euro indices are seeing some selling pressure as market participants remain cautious ahead of the Fed and BoJ policy meetings this week – the market continues to digest the possibility of a Fed rate hike in the near future despite expectations of the Fed to keep policy unchanged this week. The benchmark yesterday came within +1% of erasing all of its Brexit losses. It’s no surprises that financial stocks are leading the losses across the board, while energy names remain the notable laggard in the FTSE 100on the back of oil stocks trading lower. Commodity and mining stocks conversely are trading higher.

In Asia, equity markets were mostly mixed despite the more negative sentiment on Wall Street yesterday. Japan’s markets were especially unsettled with more headlines pertaining to stimulus mix happened to drive the Nikkei225 down -1.5%.

Indices: Stoxx50 -0.2% at 2,964, FTSE +0.2% at 6,722, DAX flat at 10,195, CAC-40 -0.5% at 4,367, IBEX-35 -0.6% at 8,522, FTSE MIB -1.2% at 16,487, SMI -0.1% at 8,188, S&P 500 Futures -0.1%

4. Crude oil prices slump again to levels not seen since April

Expanding gas inventory and increased drilling in the U.S. continues to be bad news for the oil market.

Crude oil this morning has managed to hit its lowest prices since May (WTI $ 42.79 -0.79%, Brent $44.53 -0.42%), pressured by concerns that a long-awaited rebalancing of the market would be delayed due to a glut in supply.

Also dampening sentiment, many traders are reducing their bets on rising prices. Speculators have cut their net “long” position in Brent and WTI crude futures by -31m barrels to +453m on July 19.

This week, U.S. inventory reports (API today 04:30pm EDT and DoE Wednesday 10:30am EDT) are expected to show a fall in crude stocks but a rise in gas supplies.

5. U.S Front-end yields remain sensitive

Short-term yields are highly sensitive to monetary policy changes and Monday’s two-year Treasury note auction is a good example of that.

Tomorrow’s Fed rate announcement has temporarily weakened the appetite for two-year Treasury product.

Yesterday’s two-year sale, which was a tepid affair, indicates how sensitive short-term yields are. The weakened demand managed to spark a fresh bout of front-end selling, pushing the 2-year yield to a fresh one-month high of +0.76% yield (higher than the +0.743% of similar debt traded before the sale). Fed-funds futures indicate that there is only a +20% chance that the Fed would tighten monetary policy by its September meeting and a +51% chance by December.

Indirect bidding, which is a proxy of foreign demand, managed to drop to +30%, the lowest since July 2014. While direct bidding was +10.3%, up from last month’s +9.9%, but below the +18% average of the past four-sales.

Investors need guidance; otherwise there will be more “sitting on the fence” occurring.

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