The desk is currently evaluating a dollar bearish narrative amidst ongoing volatility in U.S. equities and geopolitical tensions. Per the full note from J.P. Morgan, the analysis suggests that the optimistic baseline for the dollar may be overly reliant on cyclical recovery assumptions. This view is supported by recent fluctuations in industrial commodities and the potential for further equity market instability, which could undermine the dollar's strength in the near term.
What the desk is arguing
J.P. Morgan presents an interrogation of the optimistic narrative surrounding the U.S. dollar, suggesting that this narrative may be overly reliant on favorable cyclicality amid significant market volatility. The analysts point to the turbulence in U.S. equities, alongside unstable industrial commodity prices, as critical factors challenging the assumption of sustained dollar weakness.
Furthermore, the geopolitical landscape adds another layer of complexity that could undermine the dollar’s bearish outlook. By refusing to take the optimistic baseline at face value, J.P. Morgan underscores the importance of revisiting fundamental data and market signals to assess whether the current narrative holds under pressure.
Where it sits in our coverage
Our consensus target for the U.S. dollar remains at 1.075, with a firm spread indicating a range between 1.04 and 1.12. This perspective aligns with J.P. Morgan's belief that the dollar faces challenges, while still keeping within a range driven by cyclical dynamics.
In terms of specific firm forecasts, we note the following insights:
While J.P. Morgan offers a critical lens on the optimistic baseline narrative, other firms hold varying perspectives. For instance, BofA maintains a contrary view, advocating for a stronger dollar and setting a target at 1.04 for Mar26.
In contrast, firms like Goldman Sachs and Citi align more closely with the cautious stance taken by J.P. Morgan, indicating that they see potential vulnerabilities for the dollar given current market conditions. Their forecasts reflect a more tempered approach amid ongoing volatility in financial markets.
01J.P. Morgan challenges prevailing dollar bearish narratives amidst market turbulence.
02Geopolitical issues and volatility in commodities further complicate the outlook.
03Need for reevaluation of assumptions propelling the dollar's weakness in light of recent market movements.
Market implications
The recent commentary from J.P. Morgan implies that currency markets should brace for potential fluctuations should the underlying assumptions of dollar weakness falter. Increased scrutiny on economic indicators and geopolitical events could dictate short-term volatility, especially if further turbulence emerges in equity or commodity markets.
Risks to this view
Key risks to this analysis include further deterioration in U.S. economic indicators that might strengthen the dollar, as well as unexpected geopolitical developments that could drive market sentiment. Additionally, persistent volatility in equity and commodity markets poses a risk to the stability of the current dollar narrative.
Hello and welcome to this At Any Rate FX podcast. I'm your host, Arindam Sandilya, and I have three familiar faces with me on the call today. Julia Tanase, James Nelligan and Patrick Locke, all senior strategists on the Global FX Strategy team at J.P.
Morgan. This was a holiday short and weekend market, so the overarching theme really was consolidation. Now, truth be told, not a ton happened, mind you, we are recording this before any potential Supreme Court decision on IEPA, so that statement may not hold in an hour's time.
But on the whole, the weekend threw up very many new threads, otherwise for us to tug on as far as existing views are concerned. The sharp sell-off in U.S. tech stocks and crypto of the last few weeks seemed to abate a little bit this week. But the questions about potential spillovers onto pro-cyclical FX are never far from the surface in our conversations.
And I have to say, I'm pleasantly surprised at how well our highest conviction, Hibida G10FX calls, specifically, Aussie and Norway, have held up in the midst of this equity volatility and also the chaotic price swings in industrial commodities, especially in the case of Aussie. Norway actually liked the move higher in oil, which only goes to show that these notionally commodity-exporting currencies are far more than just simple terms of trade stories. Ex-cyclical strength, as reflected in, say, last week's strong CPI print in Norway or this week's strong Australian jobs data, is a key component of the story that informs a hawkish bias on the respective central banks.
You know, there's also some positive flow asymmetries to boot in the form of Nordisk Bank FX purchases or Aussie superannuation funds, FX hedging and so on. But on the whole, the dollar did back up towards 98 on the DXY that came after hawkish leading Fed minutes. That's probably caused some pain for new limited yen bulls.
That wasn't entirely on the bingo card for us, and it probably deserves some unpacking this week. Then in my neck of the woods, people are concerned about whether the end of the Lunar New Year holidays next week will bring with it a different set of currency trends in APAC, especially in CNY, as it often ends up being the case that on a seasonal basis, when corporate dollar conversion to either pay bonuses or settle vendor payables out of the holidays is done, dollar CNY and broadly dollar Asia tends to inflect higher. And then there is this perennial question of the weekend threat of Iranian geopolitics, which seems to have taken on a new urgency of late.
So rather than flog a very dead horse in terms of our model views on dollar bearishness and pro-risk bullishness that regular listeners should be more than aware of at this point, I thought that we'll spend the next few minutes interrogating our optimistic baseline along some of these risk dimensions. So maybe, James, I'll start with you on the issue of equity sectoral churn in the U.S., volatility, VIX creeping high above 20, spillovers on to cyclical effects. So this is one of the FAQs that crops up in our conversations and in client meetings.
So key one to you is how much does this worry you and what should we be watching here? Yeah, so I think there's in terms of the equity rotation that you mentioned that, you know, there's a few different angles to it in terms of part of it is better global growth. Part of it is relative valuations and what the market may or may not think about those in relation to kind of U.S. tech.
Part of it is AI disruption that we've seen over the last few weeks in different sectors. And all this is happening while kind of, you know, U.S. equities are sitting on kind of range lows, but U.S. and global data surprises are at the highs. So one thing we feel kind of comfortable saying is this isn't a growth driven U.S. equity weakness, which which is what would worry us a bit more in terms of our pro cyclical positioning.
You know, if you look at. Relative equity performance in relation to relative earnings growth, they are actually tracking each other, so this isn't a dislocated move in relative equity performance, it's it's it's tracking relative earnings growth, which, again, gives us a bit more confidence in terms of the pro cyclical thinking. You are also seeing risk parity strategies working.
So yields are offering a little bit of a cushion to equities and that that keeps kind of one channel, a little bit of a narrow channel, but for dollar weakness open. So it's not not as much kind of the stagflationary backdrop that we saw a few years ago. And the thing that's probably most important to me is some of the equity internals outside the U.S. are suggesting that we're going to get some pretty strong PMI numbers, which is obviously what what cyclical assets have begun to price.
We have actually seen that data in some places. So if you look at like New Zealand PMI, UK, ISM in the U.S., we haven't yet seen it in Europe. European equity internals are very, very, very positive.
And, you know, we saw obviously a beat on the PMI today in Europe. But, you know, my view, it's still kind of falling a little bit short of what equity internals are suggesting. So let's you know, I've got a bit of patience there.
But, you know, I'd say let's let's wait for the next one or two prints and see how we do. European data surprises still still at the highs. And I think, you know, part of what's held cyclical effects back this week is, you know, partly the geopolitical risk, which Patrick will talk about.
But also, I think something a bit more nuanced in terms of what AI disruption is saying for rate spreads. And if you're going to bring inflation expectations lower at the two year point driven by potential AI disruption to the labor market, that's actually supported real rates at the front end of the U.S. curve, even as nominal rates have come lower. And that's made it a little bit difficult, a little bit more difficult to see dollar weakness, even as the equity relative equity performance has moved further in favor of dollar weakness.
That's why I think you've had that little dislocation this week where between, you know, because because rates have actually been a little bit more of an important driver than equities. So what do we need to see? I think we need to see rest of world growth data do a little bit more of the heavy lifting, which which, you know, are indicated in our leads and our models are telling us is going to come through.
We've seen a little bit of a stall in our growth revisions, but we're willing to be patient on this data and and see how we go. And I think the PMIs overall today so far have been a bit of an encouraging sign. OK, very good.
Let's just hope that this subsurface sector rotation remains exactly that and doesn't spill over into broader indices. I guess one of the points that you've made in one of your notes is just keep watching credit spreads for whether this takes on an uglier term. If it does, then obviously we have to revisit our thesis on on cyclical assets and cyclical effects.
But he talked about disconnects. And so, Junya, next question to you. A very noticeable disconnect in Japanese fixed income versus FX markets, you know, long in JGBs where yields have ostensibly depriced some fiscal risk premium, noticeably cooled down over the past two to three weeks versus the lack of follow through lower in dollar yen.
I think that's caused a lot of frustration amongst short term investors. It's caused a lot of head scratching, judging from the number of questions that have come through. Why is YenFX seemingly unwilling to price out fiscal risk when yen rates look much more agreeable to the idea?
Thank you very much for the question. As a baseline and starting point for the discussion, relevant discussions, I would insist that the relationship between yen's interest rates and yen's FX rate is not historically stable necessarily. And the relationship between the two is conditional and could be changing quickly.
So, this is a starting point. And the recent decline in the long end and the super long end JGB yield is mainly due to the easing of fiscal concerns after the LDP's landslide victory in the lower house election. With the LDP holding a strong majority, market has strengthened the view that there is less need to accommodate every opposition demand, totally different from the last November's supplementary budget case.
And that consumption tax cut will likely be one of the measures as was promised by LDP. On the fiscal policy, the current market focus is funding sources for consumption tax cut and the size and financing measures of the expected supplementary budget accompanying the growth strategy. Both are expected to be decided around June, suggesting it may take some time before fiscal concerns will resume.
This fiscal year's initial budget is reportedly targeted for passage until late April, but we do not expect any major surprises on this. Given that, over the next few weeks, fiscal policy is unlikely to be the major market driver and the risk premia should remain subdued. Historically, the correlation between long end and super long end JGB and the yen has not been consistently negative.
And the negative correlation observed after the launch of Takaichi Administration arose in the idiosyncratic context in which fiscal premium became the main driver of both yen rates and the yen's exchange rate. Therefore, if fiscal premium recedes, the relationship between yen rates and the yen exchange rate can revert to its usual positive correlation. The recent softening of yen despite the lower JGB might suggest the start of such kind of shift.
Since the LDP leadership election last October, the yen has shown a negative correlation with US-Japan 1-year forwarded 1-year rate differentials. This relationship has mainly been driven by a negative correlation between yen and the yen's 1-year 1-year rate. We believe the main driver of negative correlation between two, from the yen rates and the yen's exchange rate, is the concern that the BOJ's policy will fall behind the curve under Takaichi Administration.
Therefore, if those concerns recede, the positive correlation between front yen and yen rates and yen could be due. Indeed, in the first quarter of last year, a rising expectation for more hawkish BOJ, partly due to the pressure from the US government, pushed front yen and yen rates higher and this was accompanied by yen appreciation. So, this means that the correlation between two was positive, not negative.
Since the election, Prime Minister Takaichi has not suggested pressuring BOJ to keep policy rate as low as possible, which may have eased market concern that BOJ will fall behind the curve to some extent. If such concerns have been diminishing, it would be reasonable for the negative correlation between front yen and yen rates and the yen to weaken, and for positive correlation to resume. Separately, the recent pullback in the Fed rate cut expectation is also supporting for the yen, regarding about the correlation between 1-year 1-year rate spread and the yen.
The easing of concern on fiscal and BOJ policy is a key for normalization in this FX relationship. As I said, as fiscal concerns are likely to remain contained at least in the near term, market attention is now shifting towards BOJ's monetary policy. The immediate focus is new BOJ policy board appointment scheduled for February 25th.
We continue to think BOJ policy will become behind the curve under the Takaichi administration, and the appointment of DABISH board member could resume such concern. That's from me. Okay, so maybe a temporary abatement of fiscal concerns, temporary being the operative word, maybe some technical reasons related to these proposed rules around unresolved losses on lifers bond portfolios, etc. may have something to do with this wedge.
But something tells me that we have not seen the last twist or turn in this fiscal and BOJ behind the curve saga. So, eyes peeled on that in the coming weeks. But Pat, now moving over to you, I guess a couple of questions in the spirit of stress testing.
You know, this dollar move up over the past week and the hawkishness in Fed minutes, what do you make of all of that? And you're sitting next to our US rates guys and speaking to our US economists all the time, so what's the view coming from there? And then, again, in the spirit of sort of asking difficult questions, thoughts about Iran, the geopolitical threat, what might it do to the overall risk complex?
Yeah, thanks Arindam. So maybe starting with kind of like, you know, the econ developments, I mean, certainly I think the minutes this week were very interesting. You know, I've said for a while that minutes have kind of become less and less interesting over the years, like just given the kind of the array and the breadth of kind of like Fed speakers that we have immediately after FOMC meetings, that kind of color in the, you know, in between the lines.
But I think certainly like there was much more willingness to consider going in the other direction here from some Fed committee members. And you take that against kind of the revisions and inflation and the unemployment rate that they had. And it's starting to align much more with kind of, you know, how our economists have been talking about how to think about the U.S. for the rest of the year, which is pretty firm growth, pretty sticky inflation.
You know, we in particular, right now we're seeing kind of like core PCE elevated to CPI, lower unemployment rate, less slack. And maybe if the Fed kind of continues to revise up its estimate of neutral, then, you know, mechanically in a Taylor rule, that suggests policy rates should be a little bit higher, not lower. So that, I think, in part motivates our call for no cuts.
And it looks like, you know, the Fed, the committee members are starting to think a little bit more along the lines in that direction. Obviously, this comes on the back of a pretty solid NFP print last week. So I think the real question is, like, why haven't the, why hasn't the short end done more?
You can't obviously link kind of the dollars rebound this week to kind of a significant rethink of either terminal, which still has more than a couple cuts priced in, or kind of like a just a broader complex move in the rates. And, you know, we continue to see like a decent discount kind of around mid-year, potentially linked to Chair Warsh starting his term, you know, but nevertheless, like, I think the lack of kind of short end move given recent developments is, is rather striking and something certainly to kind of keep an eye on. So that's one.
And then, yeah, as I would say about kind of like, you know, the US Iran situation, I guess I would make a couple points. First is that, you know, it's pretty interesting. I think that the macro backdrop is actually reasonably comparable to what happened when the US attacked Iran last summer, which was basically a pretty positive growth environment, kind of like, you know, the reopening or kind of like depricing of tariff beers after Liberation Day.
Dollar positioning was shorter than it is now. But, you know, both are pretty decent sized dollar shorts. So definitely some kind of like, you know, comparability there, I think.
And then you look at kind of the relative price action, you know, most notably, after last year, oil sold off after the attack, equities kept rallying. And basically, the dollar sold off fairly meaningfully on a broad basis, after basically rallying kind of like into the event, along with oil risk premium, if you would. So that altogether suggests that perhaps there is a path in this case, where even if there is an attack on Iran, then perhaps it's not necessarily going to be kind of like a major deleveraging, de-risking kind of episode where dollar shorts get unwound and kind of the pro cyclical trade, and the rotation that everyone has been very interested in lately, it's, you know, kind of runs into a wall.
That's not, based on recent history, that's not necessarily guaranteed. But obviously, you need to tread lightly with these things. I think at the end of the day, ex post, the intervention last June was probably relatively surgical, quick in and out, didn't last very long.
We don't know kind of the objectives or the goals, if they were to attack this time, how long it might last. And obviously, that all will eventually get factored into how markets ultimately respond and how risk premium trades or gets depriced. So certainly not kind of like projecting anything with absolute confidence here.
But I'd say for those interested in like maintaining kind of the pro-risk bias, I think last year's episode, at least is a good indicator that some of these exogenous geopolitical shocks don't necessarily have to result in kind of a major deleveraging. Well, I hope you're right on that one. But if for people who are interested in kind of hedging this, this tactical threat, my only observation is if you look at Patrick's positioning monitor, which is an excellent publication, by the way, you will see that of all the Haven FX, I'm just struck by how short positioning continues to screen on the Swiss franc.
It's one where we are modally calling for weakness as well. But obviously, on any sort of geopolitical risk off, I think those shorts are vulnerable to being rinsed in a volatile fashion. All right, at my end, let me just finish up with some quick thoughts on CNY and the end of the bullish lunany or seasonal window and what it may or may not mean for R&B going forward.
Look, if this was any other year, I'd have said every chance that a three, four months long bullish CNY trend almost in a straight line will take a breather. I think the reason why this year could be different is that US and China are locked in trade negotiations, as we know, in the lead up to President Trump's state visit to Beijing in early April. We generally know that FX policy has been a renewed focus of late as far as North Asian trade partners go, and albeit the multi-pronged policy levers that Korean authorities have pulled since late December to stem the tide of one weakness, be it the joint rate check on dollar yen in late January, or the explicit calling out of the need for CNY appreciation in the latest US treasury report that Patty had flagged on this podcast last week.
So, you know, it is not inconceivable and fully acknowledge that we are guessing from the outside here that some sort of CNY appreciation in exchange for tariff relief could be a potential quid pro quo that's on the table, one that would make the Chinese side reluctant to upset the apple cart on CNY before the Trump visit. So which is why my guess is even if the fixings fall more slowly than before from here and the pace of CNY appreciation flags a little, the trend probably won't reverse wholesale. But the proof of the pudding will be in the fixings and the CNY spot price action when China returns from holidays next week.
All eyes will be on the 9.15am fixed release on Monday. So lots to play for, not just for CNY but also correlated plays like Aussie. Okay, so let's leave it there for this week.
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