Forex - USD/JPY Flows: Chinese trade retaliation hitting the USD, declines likely to accelerate


 13:29 (GMT) 13 May

  [Forex Flows]

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USD/JPY Flows: Chinese trade retaliation hitting the USD, declines likely to accelerate (0101-LGBN-C01)

We are in a similar situation to where we were towards the end on 2018. Positioning is close to the highs on USD/JPY, and yield spreads are heading lower. Trade wars are breaking out again, and equity markets are falling and volatility rising, reducing the attraction of the carry trade. So far the FX market reaction has been comparatively modest, but things have started to heat up with the announcement of China's retaliatory tariffs.

USD/JPY Flows: Chinese trade retaliation hitting the USD, declines likely to accelerate (0101-LGBN-C02)

We would expect the USD declines to start to accelerate from here, partly because we are starting from such low levels of volatility. The USD has been favoured as a positive carry trade, and its attraction has been increased by declining volatility. Up to now, FX volatility had barely risen, in spite of the declines in equities and some pick up in equity volatility. While implied volatility has picked up modestly in USD/JPY, its rise has been restricted by the still very low level of realised vol. As USD/JPY falls and realised vol picks up, so implied vol will have more potential to rise. We would consequently expect USD/JPY declines to accelerate, much as they did twoards the end of 2018. While this might not mean a "flash crash" there is probably more risk of a general USD decline this time, as yield spreads are moving aganst the USD on a broader basis, with Eurozone weakness already priced into the market, and EUR short positions more extended.

USD/JPY Flows: Chinese trade retaliation hitting the USD, declines likely to accelerate (0101-LGBN-C03)

The USD has outperformed yield spreads this year largely because of the decline in volatility. If volatility rises and carry trades are unwound, there is a good chance of moving back in line with yield spreads, suggestng scope to 106 in USD/JPY and 1.15 in EUR/USD.

USD/JPY Flows: Chinese trade retaliation hitting the USD, declines likely to accelerate (0101-LGBN-C04)

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