A sense of normalcy returned to US markets with the major US indices moving back into green numbers on Tuesday. The yen, which was arguably the source of the market calamity witnessed on Monday, has stabilised somewhat however the story of yen strength may not yet have run its course. The surprising extent of the BOJ (Bank of Japan) interest rate rise last week sparked a seismic deleveraging event, as funds flowed out of global investments and back into Japan as vast amounts of yen were repatriated.
It is still a guessing game as to how much of the carry-trade unwinding is still to come. As the yen has been virtually the ‘automatic’ choice as a funding currency for the last five years, naturally there are still short-yen positions existing. If further unwinding of short-yen trades are more gradual in nature, then markets can likely better absorb the moves than what we saw on Monday. This will depend on how the yield differential between the US and Japan performs in coming months, with both the Fed and the BOJ on divergent Monetary Policy paths. For the time being, markets have ‘steadied the ship’ however the contrasting interest rate trajectories around the globe means there could be further installments of the carry-trade unwind.
Expectations of an increasingly dovish Federal Reserve have taken a toll on the Dollar Index (DXY). In early Asian trading hours on Wednesday, the DXY had edged up from the lows to sit just shy of the 103 level. However, the prospect of a potential 50bp cut come September from the Fed continues to plague the USD. There is a lot of economic indicators and economic events to come between now and September, and the jobs miss from Friday and subsequent market reaction may yet prove to have been exaggerated.
The Aussie Dollar progressed past the 0.65 level against the USD after the RBA Monetary Policy meeting on Tuesday kept the prospect of a possible rate rise in play. Meanwhile, the USDJPY rate, which has sunk 10% over the past month, has moderated around the 144.50 level. Looking ahead for USDJPY, resistance sits at 146 and 147.73, while support awaits at 143.30 and 142.20. Though, the USDJPY rate could remain a rollercoaster given the carry-trade dynamics at play as yield differentials shift between Japanese and US bond yields.
The moderate bounce in treasury yields and the USD contributed to the gold price again sliding under the $2400 level. Gold has been left to play second-fiddle to the yen trade, however the fundamental picture remains supportive of the precious metal given the Fed is primed to cut interest rates. Gold should find some support between $2375 and $2361 if selling pressures persist. Elsewhere, the oil price remains absent of any risk-premium despite the escalating tensions in the Middle East, with global economic concerns weighing heavily on the price of crude.
Looking ahead, financial markets will be on the lookout for any ongoing volatility in the bond market, while Chinese inflation data on Friday will also be monitored. But for now, it’s a case of investors treading cautiously given the spike in volatility. I expect the USDJPY rate to be a good indicator of whether there is further downside to come for risk-assets in the short-term.
