Market Brief: Currency Market Price Action Begins to Accelerate

The Bank of Japan raised benchmark lending rates and announced plans to cut its monthly bond purchases by half in last night’s meeting, moving closer to unwinding an unconventional monetary policy programme that began in the late nineties. Surprising—but not shocking—market participants, the central bank under Governor Kazuo Ueda lifted the target for the uncollateralised overnight call rate to 0.25 percent, up from the previous zero-to-0.10 percent range, and said it would gradually reduce government bond purchases to around ¥3 trillion a month by early 2026, down from the current ¥6 trillion. With internal Bank forecasts pointing to a self-reinforcing process of rising wages, stronger consumer spending, and higher inflation ahead, Ueda said “We plan to continue raising our policy rate and adjust the degree of monetary accommodation,” if the economy continues on its current trajectory.

After remaining initially unmoved, the yen is now sitting on a circa-1.5-percent gain, suggesting that positioning-related dynamics are playing a role in driving short-term price action. A sustained move out of the 150 - 160 range against the dollar looks likely—particularly if the Federal Reserve begins telegraphing rate cuts ahead—but we’re not confident the decision represents a watershed moment for the exchange rate, given the still-huge rate differentials on offer between the yen and currencies elsewhere. The Bank of Japan’s capacity to set yields at the margins will remain largely intact after last night’s decision, capping upside. We think many speculators will re-initiate yen-funded carry trades as declining US yields support global risk appetite, and think the currency will struggle to recover pandemic-era losses in the near term.

Oil prices are up after Hamas said Israel killed its political leader, Ismail Haniyeh, in a technically-astonishing airstrike on Tehran. Both the global Brent and North American West Texas Intermediate benchmarks are holding gains in the 2.5 percent range on an overnight basis as traders brace for retaliation from Iran, but with disappointing Chinese demand growth weighing on markets, both remain down more than 5 percent on the month. A wider-scale confrontation—particularly one involving Iran's oil refineries and export terminals*—could upset this delicate balance and send prices spiralling upward.

The euro is up modestly after bloc-wide inflation accelerated more quickly than expected in July, slightly dampening hopes for two rate cuts from the European Central Bank by year end. Headline prices rose 2.6 percent on a year-over-year basis, up from 2.5 percent in June, while the core measure targeted by policymakers gained 2.9 percent for a third consecutive month. Data out yesterday showed the economy expanding more quickly than expected in the second quarter, but a contraction in the German growth engine helped cloud the outlook, suggesting that the recovery is likely to remain weak.

Market-implied odds on a rate hike at tomorrow’s Bank of England meeting are holding above the 60-percent threshold as growing slack in the domestic labour market and softness in the European economy translates into a slightly weaker outlook for the UK. Economic surprise indices—which measure the difference between consensus forecasts and realised data—have drastically outperformed their American cousins in recent months, helping the pound deliver a world-beating performance, but past history would suggest that this is unlikely to be sustained for long. The exchange rate might remain well-supported as long as a broad-based deceleration in the US economy continues, but domestic frailties could yet reassert themselves, blocking a sustained move into the mid 1.30’s against the greenback.

The dollar is trading on a more defensive footing as traders position for a clear easing signal in this afternoon’s Fed decision. The central bank is overwhelmingly expected to leave its main policy settings unchanged, and the official statement is likely to remain largely intact, but a few key sentences should be modified to reflect an evolving outlook. A passage noting “modest further progress” in slowing price growth could be modified to say “continued progress”. Policymakers could say that the risks to achieving employment and inflation goals have “become balanced”, instead of moving toward “better balance”. A sentence that previously read “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent,” might see extensive revision, now suggesting that officials “will act as appropriate to sustain the expansion”.

In the post-decision press conference, Chair Powell is unlikely to give a full-throated voice to calls for a September move, but will be hard-pressed to avoid acknowledging a softening in the economic backdrop, with the second half of the Fed’s mandate coming under increased threat. The unemployment rate has been grinding higher for months, and could come perilously close to the Sahm recession-dating rule when updated on Friday. Yesterday’s release showed the number of job openings remaining unchanged at 8.2 million in June as revisions boosted May’s total, but the ratio of vacancies to unemployed workers slid to 1.20, and “excess labour demand”—the difference between the available labour force and the sum of employed workers and job openings—fell below its pre-pandemic peak. The data is not yet consistent with an imminent downturn, but certainly seems supportive of a less restrictive stance from the Fed.

*This unverified article (external link) seems to suggest that Israeli forces used GPS systems to warn Tehran of a potential strike on oil infrastructure while engaging targets in Houthi territory on July 20.

Please note: I will be off on a brief summer hiatus next week, with the morning Market Brief pausing publication between August 5 and 9. Our market and economic dashboards will continue updating of course, check them out here

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