Market Brief: Ructions in Japanese yen dominate global currency markets

The dollar is back on the defensive after the yen posted its biggest two-day gain since last month's historic US-Japanese intervention. Brent crude is trading just below $95, after this week's escalation in military hostilities between the US and Iran. Sovereign-bond yields are steadying below their recent highs, and equity futures are holding firm ahead of the North American open. The euro and pound are treading water amid a lack of domestic catalysts.

The yen is up almost 2%, having surged twice in the last day. The causes are somewhat mysterious. One possibility is that the moves were triggered by rate checks or outright intervention from the Bank of Japan or the New York Fed, but there has been no independent confirmation of that, and the price action does not look consistent with official buying*. A second is a shift in the policy outlook, but overnight index swaps are pricing in a 25-basis-point hike at the central bank's September meeting followed by moves in January and April, little changed from a few days ago. A third—and in our view more convincing—explanation is that investors are front-running a shift in the allocation of the Government Pension Investment Fund, the world's largest, toward domestic Japanese bonds. Capital outflows, more than rate differentials themselves, have been the biggest factor in driving the yen lower in recent years, so a shift in direction could have a meaningful impact on the outlook**.

The Canadian dollar is trading on a firmer footing after the Bank of Canada struck a less dovish note than markets had expected, expressing more concern about price pressures than trade risks. In the statement accompanying yesterday's decision, officials said “upside risks to inflation have increased, while new tariffs make growth prospects more uncertain,” and dropped an earlier line describing the policy rate as “at the right level”. Governor Tiff Macklem adopted a more hawkish stance during the post-decision press conference, downplaying the latest round of tariffs from the Trump administration, saying the Bank does not “expect a big ongoing impact on overall economic activity,” while warning “Inflation is running too high, the situation in the Middle East is no closer to resolution, and the longer it goes on, the bigger the chance it feeds through” into broader price measures. Investors are now pricing the first rate hike by December***, with a second and third following by March and June.

Today will bring a raft of important data releases, but an appearance from Federal Reserve governor Christopher Waller could prove most consequential. Weekly jobless claims, July trade balance numbers, the Institute for Supply Management's services index, and an updated purchasing managers' survey are all due in the coming hours and could help recalibrate views on the economic outlook. Investors will, however, pay close attention when Waller—often seen as a bellwether for sentiment shifts on the rate-setting committee—takes part in a moderated conversation with Reuters at around 8:30 this morning.

In mid-July, Waller indicated that consistently hot price readings might push him to vote for an imminent rate rise, but he’s provided little guidance since. His counterpart, the New York Fed’s John Williams, yesterday told CNBC that bond yields were being driven up by strong nominal growth and an improving outlook for technology investment, pinning elevated inflation on tariffs and the war in the Middle East, and saying his own decision on September 16 would “depend on the data and depend on some of the risks to achieving our goals”. A similar equivocation could leave markets in neutral, while a more hawkish tone could see rates and the dollar springing higher.

Tomorrow's non-farm payrolls report will influence rate expectations but will almost certainly be overshadowed by next week's inflation update. Economists think the economy added 53,000 jobs in August, an improvement on July's surprise loss of 23,000, with the unemployment rate holding steady. A disappointment could weigh on front-end rates and the dollar; an upside surprise might see a September hike fully priced in. Yet Fed officials, Kevin Warsh among them, have recently downplayed labour market developments, arguing that weak job growth is consistent with a slower-growing workforce and suggesting that inflation risks now loom larger in the central bank's reaction function. The consumer price index update due on September 11 will ultimately clinch—or break—the case for a move.

*Exchange rate moves in the aftermath of intervention efforts are typically characterised by a sharp move upward, followed by more incremental gains in the following minutes and hours. In both cases in the last day, the yen jumped higher and then retreated.

**One has to be careful when interpreting frustrated-hedge-fund-investor-turned-Treasury-Secretary Scott Bessent's words, but this may be what he was referencing when he told CNBC in late August "I have asymmetric information," so "the market should think: ‘Why would we have joined the Japanese in the intervention at this time? Do we know something the market doesn’t know?'".

***I'm not confident in this outlook, and think the currently-unfolding hit to business confidence could push rate hikes well into 2027. The Canadian dollar spot rate is, however, aligning nicely with my June forecasts, so I won't look the gift horse in the mouth too closely***.

****Remember that God invented economists to make weather forecasters look good, and then invented FX strategists to make the economists look good.

Market Overview

Data as of 7:15 AM EDT

Notes: DXY: Dollar index, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

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