GBP JPY - FUNDAMENTAL DRIVERS

GBP

FUNDAMENTAL BIAS: NEUTRAL

1. Monetary Policy

In March the BoE hiked rates by 25bsp as expected but delivered a bearish hike with BoE’s Cunliffe dissenting by voting to leave rates unchanged. This was a stark change from February where 4 members voted for a 50bsp hike. Cunliffe noted the negative impacts of higher commodity prices on real household incomes and economic activity as the main reason for his dissention, while remaining members thought a 25bsp hike was appropriate given the tight labour market and risks of second round effects. Even though inflation forecasts were upgraded to 8% in Q2 (previous 7.25%), the negative view that GDP was expected to slow to subdued rates showed growing concern of stagflation. The most bearish element of the statement was a change in language regarding incoming rates where the bank said they judge that some further modest tightening MIGHT be appropriate where previous guidance said more tightening was ‘LIKELY TO BE’ appropriate (a clear push against overly aggressive rate expectations). They further pushed back by noting the current implied rate path would see inflation would be below target in 3 years’ time, in other words saying they won’t hike as much, and confirms our estimates that policy reached peak hawkishness in February. The 100% odds of a 25bsp in May drifted to just above 80% on Friday, and markets will pay close attention to incoming BoE speak, where further push back against rates could be enough to see markets pricing out some of the >5 hikes still priced for 2022. As a result of the clear dovish tilt, we have adjusted our assessment of the bank’s policy stance to NEUTRAL.

2. Economic & Health Developments

With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces stagflation risk, as price pressures stay sticky while growth decelerates. That also means that current market expectations for rates continues to look too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.

3. Political Developments

Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.

4. CFTC Analysis

Very bearish signal from all three participant categories with the aggregate positioning (non-commercials, leveraged funds and asset managers) pushing below 1 standard dev from the 15-year mean. It’s important to note that this sentiment was clearly reflected given the big drop in Sterling this week.



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 is jittery. Even though that doesn’t change our med-term bias for the JPY, it does means 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, we think that opens up more room for curve flattening to take place. In this environment there could be mild upside risks for the JPY if US10Y corrects, but we shouldn’t look at the yield correlation in isolation and also weigh it alongside risk sentiment and price action in other safe havens.

4. CFTC Analysis

Very chunky unwind in net-short in the recent CFTC update, but positioning is still very stretched with aggregate JPY positioning still close to 2 standard dev away from a 15-year mean. Even though the med-term outlook remains bearish , the risk to reward to chase the currency lower from here is not very attractive.