AUD JPY - FUNDAMENTAL DRIVERS

AUD

FUNDAMENTAL BIAS: NEUTRAL

1. Monetary Policy

In Dec the RBA kept rates at 0.10% and weekly bond purchases at A4bln until mid-Feb, as expected. They reiterated that they are committed to maintaining highly supportive monetary conditions and won’t raise rates until actual inflation is sustainably within their 2%-3% target range. They noted that the economy is recovering from the Delta slowdown and is expected to return to pre-Delta path in 1H22. The positive take away from the meeting was that the Omicron variant is not expected to derail the recovery. The bank said they’ll consider the future of their QE program at the Feb meeting. Furthermore, the bank also outlined their criteria for deciding on the future of bond purchases, which include [1] actions of other central banks, [2] bond market functioning and [3] actual and expected progress towards the goals of full employment and inflation consistent with the target. All in all, the bank still had a dovish stance but was more optimistic about the economy than expected.

2. Economic & Health Developments

There are 4 key drivers we are watching for Australia’s med-term outlook: [1] The virus situation – so far, the RBA is positive about the post-Delta recovery, so incoming data will be crucial to see whether that optimism is justified. [2] China – After months of waiting, the PBoC finally stepped up with easing & news of fiscal stimulus coming in early 2022 is a very important positive development for the AUD. Politically, the recent AUKUS defence pact could see retaliation from China against Australian goods. [3] Commodities – Iron Ore, (24% of exports) and Coal prices (18% of exports) are important for terms of trade, and with both of them pushing higher on the PBoC easing, that is a positive for the AUD. [4] Global growth – as a risk proxy, where the global economy goes from here will be another important consideration for AUD, with more focus on China though.

3. Global Risk Outlook

As a high-beta currency, the AUD benefited from the market's improving risk outlook coming out of the pandemic as participants moved out of safe-havens. As a pro-cyclical currency, the AUD enjoyed upside alongside other cyclical assets supported by reflation and post-recession recovery best. If expectations for the global economy remains positive the overall positive outlook for risk sentiment should be supportive for the AUD in the med-term, but recent short-term jitters are a timely reminder that risk sentiment is also a very important short-term driver.

4. CFTC Analysis

Latest CFTC data showed a positioning change of -1607 with a net non-commercial position of - 81792. As outsized net-shorts are usually seen as a contrarian indicator we want to be mindful of potential squeezes, which means the AUD is likely to be more sensitive to positive data than negative data. The recent positives from China already saw shorts being squeezed last week, and as long as Omicron doesn’t cause a global meltdown the prospects is looking better for the AUD into 2022.

5. The Week Ahead

In the week ahead the main drivers for global markets will of course be the huge amount of central bank meetings, so risk sentiment will be important for the AUD on the back of that. Specifically for Australia, the markets will of course be watching the virus front with any outbreaks of the Omicron variant could see markets expect more restrictions for Australia. On the data front there will be a lot of focus on the employment report as it’s a key consideration for the RBA, not only for rates but also regarding the QE. Expectations are for a print of 200k, and an Unemployment Rate drop to 5.0% from 5.2%. As always there will be more focus on the full-time component. Even though one employment print isn’t going to immediately change the RBA’s mind, a very solid print would
probably be enough to see a further unwind in those stretched shorts and could provide a decent short-term lift for the AUD this week.


JPY

FUNDAMENTAL BIAS: BEARISH

1. Monetary Policy

At their Oct meeting the BoJ left policy settings unchanged with rates kept at -0.10% and the JGB yield target kept close to 0%. As usual we saw BoJ’s Kataoka as the only dissenter on YCC. In terms of the economic projections, the bank lowered both their growth and inflation targets as was previously reported prior to the meeting. The bank lowered FY2021 GDP to 3.4% from the prior
3.8%, and lower FY2021 Core CPI to 0.0% from the previous 0.6%. The bank’s outlook report once again explained that Japan’s consumer inflation is likely to gradually grind higher and noted that exports and output are currently weak due to the ongoing supply constraints. However, as with their prior meeting the bank explained that both exports and output is increasing as a trend. At the press conference, Governor Kuroda said that a soft JPY raises costs for households and imports but that he does not think current JPY weakness is a bad thing. He further added that it is desirable for FX to move in a stable manner, reflecting fundamentals and that he thinks the JPY’s current price action reflects the fundamentals. The Governor also added that YCC could lead to a weak JPY as it widens interest rate differentials.

2. Safe-haven status and overall risk outlook

As a safe-haven currency, the market's risk outlook is the primary driver of JPY. Economic data rarely proves market moving; and although monetary policy expectations can prove highly market-moving in the short-term, safe-haven flows are typically the more dominant factor. The market's overall risk tone has improved considerably following the pandemic with good news about successful
vaccinations, and ongoing monetary and fiscal policy support paved the way for markets to expect a robust global economic recovery. Of course, there remains many uncertainties and many countries are continuing to fight virus waves, but as a whole the outlook has kept on improving over the past couple of months, which would expect safe-haven demand to diminish and result in a bearish outlook for the JPY.

3. Low-yielding currency with inverse correlation to US10Y

As a low yielding currency, the JPY usually shares an inverse correlation to strong moves in yield differentials, more specifically in strong moves in US10Y. However, like most correlations, the strength of the inverse correlation between the JPY and US10Y is not perfect and will ebb and flow depending on the type of market environment from 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 with US02Y likely pushing higher while US10Y underperform. In this environment we do see some mild upside risks for the JPY, but we should not look at the influence from yields in isolation and also weigh it up alongside underlying risk sentiment.

4. CFTC Analysis

Latest CFTC data showed a positioning change of +15785 with a net non-commercial position of - 63081. The risk off tones during the past two weeks and the subsequent gains in the JPY showed why stretched positioning is such an important consideration. Even though the JPY’s med-term outlook remains bearish, the big net-shorts for both large speculators and leveraged funds always increases the odds of mean reversion when risk sentiment deteriorates. However, the size of the recent unwind has been substantial and leaves room for some downside if risk assets can continue their recovery that started last week.

5. The Week Ahead

In the week ahead the main drivers for global markets will of course be the huge amount of central bank meetings, so risk sentiment will be important for the JPY on the back of that. We also have the BoJ coming up later in the week, but as usual markets are not expecting the bank to create any meaningful volatility for the JPY. With Omicron on the radar, the bank has yet another excuse to just keep the gravy train running as they’ve done for the past three decades which means the bigger influence for the JPY in the week ahead will be risk sentiment and of course US yields.