USD/JPY: Strongest Rally Since 1988 On Widening Bond Spread
- The election of Donald Trump as U.S. president has done nothing to change the Federal Reserve's plans for a rate increase "relatively soon," Fed Chair Janet Yellen said on Thursday in Congressional testimony.
- Yellen said the U.S. central bank would change its outlook as necessary as the new administration rolls out plans for perhaps hundreds of billions of dollars in tax cuts and additional government spending. She also suggested the new government keep in mind that the United States is near full employment and inflation may be rising.
- There had been some uncertainty about how Yellen would interact with a new president who at turns during the campaign spoke favorably of the Fed's low rate policies, and yet also accused the Fed of acting politically to help Democratic nominee Hillary Clinton. Trump, during his election campaign, had also said he would replace Yellen when her term expires. Asked directly by a member of the Joint Economic Committee on Thursday, Yellen said she planned to serve out her term as chair, which ends in 2018.
- Federal Reserve policymaker James Bullard said he is leaning towards supporting an interest rate increase in December and argued that the real question now is the Fed's rate path in 2017.
- The Labor Department said its consumer price index increased 0.4% last month after rising 0.3% in September. In the 12 months through October, the CPI advanced 1.6%, the biggest year-on-year increase since October 2014. The CPI increased 1.5% in the year to September. The so-called core CPI, which strips out food and energy costs, climbed 0.1% last month after a similar gain in September. That slowed the year-on-year increase in the core CPI to 2.1% from a 2.2% rise in September.
- In another report, the Labor Department said initial claims for state unemployment benefits dropped 19k to a seasonally adjusted 235k for the week ended November 12, the lowest level since November 1973.
- U.S. Treasury yields rose on Thursday after data suggested the U.S. labor market is tightening and inflation is beginning to gain traction, which prompted investors to sell government debt.
- The Bank of Japan on Thursday fired a warning shot to markets by offering to buy unlimited bonds for the first time under a revamped policy framework, as domestic debt yields surged in the wake of Donald Trump's upset U.S. election victory. BOJ Governor Haruhiko Kuroda said the central bank will not stand idly by as Japanese government bond yields jumped in sympathy with moves in U.S. Treasuries, taking the challenge to markets as policy makers tried to keep borrowing costs low to spur stubbornly low inflation. The BOJ offered to buy an unlimited amount of bonds at minus 0.04% in the five-year JGB notes and minus 0.09% in the two-year paper, employing a method the bank unveiled in September to achieve its new policy to control the entire yield curve, rather than just short-term interest rates.
- Let us take a look at the spread between 10-Year U.S. Treasury and 10-Year JGB.
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- The dollar climbed against the yen on Friday to hit a six-month high of 110.92. It had gained around 7.5% in the last two weeks against the Japanese currency, its strongest showing since January 1988 and its second-strongest performance in the era of floating exchange rates. We expect a corrective move in the coming days, but the medium-term outlook remains bullish.
AUD/USD Dropped On Narrowing Yield Differential
- The Australian dollar sank to multi-month lows on Friday due to the greenback's broad strength after Federal Reserve Chair Janet Yellen signalled U.S. interest rates will probably rise next month.
- The Aussie was among the best performing major currencies until the U.S. election this year, thanks to carry trades where investors borrow in safer assets to buy riskier, high-yielding currencies. Over the last eight sessions it has nearly erased its 2016 gains. Investors are worrying that Fed rate hikes will neutralize the yield differential which had supported the AUD.
- Let us take a look at the spread between 10-year U.S. Treasury and 10-year Australian bond.
- Narrowing bond yield spread is an important reason for recent AUD/USD drop. However, we do not expect this would be a long-term trend. We think that further monetary easing in Australia is unlikely, which should support the Australian bond yields soon. Our AUD/USD strategy is to stay sideways.
