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)

Forex - USD/CAD Flows: Massive rise in employment triggering test of 1.34


 12:44 (GMT) 10 May

 [Forex Flows]

Canadian employment rose 106k in April - the largest rise since 2010 - triggering a USD/CAD dip to test 1.34. This comes after a series of gains over the last 8 months, underlining the strength of the Canadian labour market, so while there might be erratic elements in the April numbers, the background of exceptional strength in employment makes it hard to dismiss.

The CAD has also underperformed relative to yield spreads in the last week as it has suffered with other commodity currencies against the background of weaker equity markets because of trade concerns. While these concerns have not gone away, it suggests scope for a CAD recovery from here if trade concerns fade as a factor or the market takes a different view of the implications for the USD, especially since speculative positioning is also significantly long USD/CAD according to the IMM data and today's slightly weaker than expected US CPI data will tend to sustain the softer tone to US yields.

All in all, a dip below 1.34 in USD/CAD looks likely from here.


Forex - USD/JPY, USD/CAD Flows: After the tariff decision, signigicant data due in the US and Canada


 19:20 (GMT) 09 May

 [Forex Flows]

Markets saw some recovery on Trump's enthusiasm for a "beautiful" letter from China's Xi but it is still far from clear that increased tariffs can be avoided. If we get a deal both the USD and CAD could prove sensitive to any strength in what is significant data tomorrow, US CPI and Canadian employment. Fed's Powell and BoC's Poloz expect recent weakness in US inflation and Canadian activity to prove temporary, and we broadly agree, and see slightly above consensus outcomes for both releases. If tariffs are imposed however, weak data could provide fuel to the fire.


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