The big thing over the last 24 hours was the appreciation of the yen. The graph below shows how closely USD/JPY tracked the movement of the Tokyo stock market. It looks to me as if the stock market was leading the FX market. That could mean the movement was due to the lower-than-expected Q4 GDP figure, which came in at +0.1% SA qoq rather than +0.2%. There was also talk of a more prosaic reason: a huge option barrier being triggered, which pushed USD/JPY down through an important technical level, namely the previous 2017 low at 107.32.
Note though that while USD/JPY tracked stocks fairly well on the downside, the currency didn’t track so well late in the day when the stock market recovered slightly. This shows the currency market’s bias to sell USD/JPY (that is, to buy yen). This may be due partly to the tepid resistance of Japanese officials, who have failed to come out with anything more than the usual bromides about how a stable currency is preferable, etc. etc.
In fact as you can see, the stocks/currency correlation was present the previous day, too. USD/JPY dropped 40 pips between the time the Tokyo stock market closed Tuesday and the time it opened Wednesday.
USD meanwhile fell along with Treasury yields as the US stock market stabilized. The Treasury market continued Monday’s good performance, which was somewhat surprising considering the much better-than-expected results from the National Federation of Independent Businesses (NFIB), the small-business association.
This was the first release of the NFIB survey since the new tax legislation was enacted and so was closely watched to see how it might affect sentiment. The answer is: increased optimism. The percent of respondents reporting that "now was a good time to expand" rose to the strongest level ever, while the percent "planning to raise worker compensation" in the next 3 months rose to its strongest level since December 1989.
Numbers like this are consistent with average hourly earnings growing over 3% yoy. Remember that it was the 2.9% yoy jump in average hourly earnings that set off the recent bout of higher yields/lower stocks/massive risk aversion. The NFIB survey suggests that this could occur again. That’s why it’s surprising to me that Treasury yields declined, as did the probability of a hike at the March FOMC meeting (slightly). Presumably the market is discounting a weak CPI print later today (see below).
The European day starts early with the release of the first estimate of German 4Q GDP. The qoq growth rate is expected to slow slightly, while the yoy rate is forecast to return to the Q1 & Q2 rate. In short, the figure probably will not show as strong growth as in Q3 but nonetheless will demonstrate that growth in Germany remains at a healthy level, supported by both domestic and overseas demand. This should give the ECB more confidence about raising interest rates – particularly with a new Finance Minister taking office in Germany who may not be so worried about fiscal rectitude. EUR-positive.
During the European day, the Bundesbank will be holding a seminar on cash. The event will once again feature speeches by senior representatives from academia, public authorities and the private sector, including Bundesbank President and ECB Council Member Jens Weidmann, ECB Executive Board member Yves Mersch, and Swiss National Bank Vice Chairman Fritz Zurbruegg. I have no idea whether they will say anything relevant for the FX markets. I would think though that cryptocurrencies might be a big topic of discussion and there could be some comments related to that subject.
Later in the day comes the main indicator of the week: the US CPI. That’s going to be a huge indicator for all financial markets, seeing as that’s what started the market volatility last week: the fear of higher inflation leading to faster tightening. The headline rate of inflation is expected to slow by two tics, while the core rate is expected to slow by one. On a mom basis, the headline figure is expected to rise 0.3%. As long as it doesn’t rise more than 0.4% mom, base effects will push the yoy rate back below the Fed’s target 2.0% yoy rate for the first time since the August CPI figure last year.
That should be good news for the stock market, which is worried about higher inflation causing the Fed to tighten faster than expected. It would also be good for risk-sensitive currencies, such as AUD. It would probably be bad news for the dollar though. JPY would also be expected to suffer.
A lower-than-expected outturn would have similar implications for the FX market, only more so. Carry trades might come back into fashion somewhat and high-yielding currencies such as AUD and NZD might be expected to gain.
A higher-than-expected outturn on the other hand would probably send US interest rates higher and the stock market lower. Both would benefit the dollar, probably. Risk-sensitive currencies such as AUD would probably fall, while the safe-haven yen might gain despite the widening interest rate differential with the US.
Generally speaking, I think it’s likely that there would be more volatility in case of a positive surprise than in the case of a negative surprise. That’s because a positive surprise would tend to confirm fears that inflation is taking off, while a negative surprise would mean only that inflation hasn’t taken off yet, not that it’s not going to take off ever.
The yen’s sensitivity to risk sentiment and interest rate differentials makes it a sensible vehicle for speculating on changes in the inflation environment. Investors who would like to trade the CPI figure should consider trading USD/JPY as well as EUR/USD.
Just as JPY tends to rise during risk-off periods, AUD tends to rise during risk-on periods. Thus one might expect AUD/JPY would be the best pair to play this indicator, but experience over the last year has shown otherwise. On a 30-minute horizon, EUR/USD has shown the closest correlation to the surprise in the headline CPI figure, followed closely by USD/JPY. AUD/JPY however has shown virtually no correlation at all. The results were similar for the core CPI, although in that case USD/JPY showed a slightly higher correlation (0.4274) than EUR/USD (0.3678). Again, AUD/JPY was near zero. This may be caused by lower liquidity in AUD during the US trading day.
US retail sales come out at the same time as the CPI figures, but I don’t think they’ll be anywhere near as influential in determining the course of things as the CPI figures are. In any case, they’re expected to be relatively weak, which would tend to reinforce the expected picture of diminishing inflationary pressures and therefore be negative for the dollar.
Overnight, Australia announces its employment data. The figure is expected to show no improvement in the unemployment rate and a below-trend increase in the number of new jobs. This could be negative for AUD.
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