Powerful Short Squeeze Continues to Lift the Yen

Overview: The greenback remains under pressure. The USD/JPY short squeeze continues, and strong wage growth has helped lift sterling to new highs since last April. Among the G10 currencies, only the Australian and New Zealand dollars are unable to sustain gains through the European morning. Emerging market currencies are also advancing, with a couple of exceptions, including the Turkish lira despite reports on foreign equity inflows. The weaker dollar and softer yields have sent gold to its best level in around three weeks slightly below $1940. It found support last week ahead of $1900.

Encouraged by talk of more stimulus from China, Asia Pacific equities rallied, though the yen's recovery meant that Tokyo did not participate very much. South Korea and Taiwan led the regional advance. In Europe, the Stoxx 600 is rising modestly for the third consecutive session and US index futures are trading with a firmer bias. Benchmark 10-year bond yields are pulling back. Australian and New Zealand yields are playing catch-up today and were off more than 10 bp. Europe's benchmark yields are down 3-4 basis points. The 10-year Treasury yield is near 3.95%. Yesterday's high was almost 4.09%. The US two-year yield is also lower around 4.83%. It peaked last week at nearly 5.12%.

Asia Pacific

Today and tomorrow, the NATO summit will be held in Vilnius, Lithuania. Leaders from Japan, South Korea, Australia, and New Zealand will also attend. As noted previously, the US and Japan have been pushing to open a NATO representative office in Tokyo. France is pushing against it and appears to have some less-high-profile allies, perhaps for the same reason that then-Senator Biden cautioned against extending NATO to Russia's border. There is the Five Eyes (intelligence sharing among the US, Australia, New Zealand, Canada, and the UK. There is the Quad (US, Japan, India, and Australia). There is AUKUS (US, UK, and Australia). To this, one needs to add the dozens of US military bases in the area (In a recently issued report, the US Congressional Research Service identified the US had 66 major military sites in the Asia Pacific area and that does not count smaller bases, training areas and other facilities. It is not like one needs to be paranoid to think there is a pattern. Moreover, imagine how the US would react and the domestic economic and political consequences if Beijing had even a tenth of those resources. Later this month the Biden administration is expected to announce new curbs on American investments in China. Beijing's actions on germanium and gallium should be seen as warning shot. Until the de-risking is further along, the vulnerabilities are significant. Note that Turkey and Hungary have lifted their opposition to Sweden joining NATO. Sweden made assurances about the Kurds and the US agreed to sell Turkey F-16 fighter jets.

The short squeeze continued to lift the Japanese yen. The greenback briefly traded above JPY145.00 on June 30, settled last week near JPY142.20 and reached nearly JPY140.40 today. It is trading in a tight range near the lows in the European morning. The next area of chart support is seen in the JPY139.50-JPY140 area. The JPY141.00 area now offers first resistance. The $0.6700 area again blocked a stronger advance in the Australian dollar. It has been bumping against it without closing above it here in July. That area also corresponds to the 200-day moving average. The (38.2%) retracement of its losses from the high set in mid-June near $0.6900 comes in a little higher (~$0.6710). Beijing is signaling more support for the economy and continues to resist yuan weakness. The PBOC set the dollar's reference rate at CNY7.1886, well below market expectations (Bloomberg survey) for CNY7.2152. The greenback briefly traded below the 20-day moving average found near CNY7.2035 today. It has not closed below the moving average in nearly three months. We argue that Beijing's efforts to steady the yuan have been helped by the stronger Japanese yen.

Europe

There are two reports from Europe to note today. First, German investor sentiment is deteriorating, seemingly reflecting economic weakness. The current assessment fell for the third consecutive month, and at -59.5 (from -56.5), it is the poorest this year. The expectations component also moved lower for the third month in a row to stand at -14.7 (from -8.5). Second, the latest UK employment data were reported. Job growth is slowing, the claimant count rose, and the unemployment rate rose to 4.0% from 3.8%. However, the Bank of England will be concerned with what is sees as elevated wages. Average weekly earnings accelerated to 6.9% (from a revised 6.7% that was originally reported as 6.5%), the highest since August 2021. Excluding bonuses, the 7.3% (was unchanged after the upward revision in the May series from 7.2%). The swaps market is pricing in an almost 80% chance of a 50 bp hike when the BOE meets next in early August and is leaning to another 50 bp hike in September.

The euro, which recorded a low near $1.0835 four sessions ago, reached its best level in two months earlier today slightly above $1.1025. It has seen some profit-taking and is now around $1.10. Initial support may be around $1.0980, but it may take a break of $1.0950 to suggest a near-term top is in place. The market does not seem quite ready to challenge the $1.11 area that stalled the single currency in April and May. Sterling rose to a new high since last April yesterday, near $1.2870 and extended those gains today to almost $1.2915. Initial resistance is seen near $1.30, with nearby support around $1.2850. Recall sterling bottomed last September near $1.0350.

America

The US Treasury sold another $123 bln in 3- and 6-month bills yesterday. Today, it comes back for more: $38 bln in one-year bills, and $50 bln of a 42-day cash-management bill. It will also sell $40 bln in 3-year notes. Tomorrow, it will sell four-week bills and $32 bln 10-year notes. Thursday sees 4- and 8-week bills and $18 bln sale of 30-year bonds. The rebuilding of the Treasury's General Account appears to be causing less tightening of financial conditions than feared as the use of the Fed's reverse repo facility has declined and banks' reserves have edged up. The week's big events still lie ahead. The June CPI is on Wednesday, as is the Beige Book, followed by the June PPI. Wednesday, the Bank of Canada meets, and the swaps market sees about a 66% chance of a quarter-point hike (to 5.0%).

The US dollar posted a key downside reversal against the Canadian dollar after the divergent employment reports before last weekend. Follow-through US dollar selling yesterday was limited, but it was extended a bit more today to about CAD1.3245. The pre-weekend high was near CAD1.3385. The 20-day moving average is found around CAD1.3235 and there is congestion in the CAD1.3200-20 area, which is likely to hold into tomorrow's US CPI and Bank of Canada meeting. The Mexican peso has recovered quickly from last week's profit-taking which saw the greenback rise to almost MXN17.3960. It reached nearly MXN17.03 yesterday and is consolidating so far today, reaching nearly MXN17.10. Last week's low of MXN16.98 has not been seen since the end of 2015. Note that there are some chunky options at MXN17.00 that expire Thursday and Friday.