FX Daily Strategy: Europe, December 19th

BoJ meeting the focus, no rate hike seen, but some risk of higher JGB yields

JPY upside favoured after Monday squeeze

CAD vulnerable to softer CPI

AUD may recover vs EUR after Monday sell off

The BoJ meeting is the main event on Tuesday. To most market participants' surprise, not only the BoJ did not aggressively bring rates to zero percent, they did not even change their forward guidance. Given the latest inflation dynamics, it is surprising BoJ would not seize the time to hint a change of monetary policy. Yet, if BoJ only want to wait for the perfect moment to exit ultra-loose monetary policy, their rationale is still supported by the fact labor cash earning has not reached 2%. While BoJ kept forward guidance "The Bank will continue with Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, aiming to achieve the price stability target, as long as it is necessary for maintaining that target in a stable manner. It will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2 percent and stays above the target in a stable manner. " intact, the text within the statement has stated "The year-on-year rate of increase in the CPI (all items less fresh food) is likely to be above 2 percent through fiscal 2024", which seems to suggest BoJ do see an exit of ultra-loose monetary policy but is waiting for wage growth to further pick up. 

USD/JPY rose strongly on Monday, likely reflecting some squeezing of short positions ahead of the meeting. It is generally expected that USD/JPY will decline in the coming year as rates elsewhere are cut and Japanese rates rise, and with some risk of a hawkish statement there were some JPY long positions in the market going into the meeting. Despite a lack of real news on Monday, these positions were squeezed. However, this creates a greater chance of a significant JPY rise in response to the meeting. JGB yields look a little low given the reference ceiling (rather than a hard ceiling) of 1% and a likelihood that yield curve control will be abandoned as part of the tightening next year. Even with spreads as they are currently, USD/JPY looks to have downside potential, as do JPY crosses, so we would see risks as being weighted towards a stronger JPY coming out of the meeting now that the loose long JPY positioning has been squeezed out.

Elsewhere we have Canadian CPI. We expect November Canadian CPI to slip significantly to 2.8% yr/yr from 3.1% in October, matching the recent low seen in June. Year ago strength is likely to assist further slowing in the BoC's core rates. Our forecast is a little below market consensus, suggesting some downside risks for the CA. As it stands, USD/CAD has in any case been outperforming yield spreads in recent days, so we see some upside risks. CAD/JPY also looks particularly vulnerable, as one of the pairs that looks both most correlated with yield spreads and most out of line.

AUD/USD fell back on Monday, perhaps influenced by the weak JPY, but this has taken it to levels that look attractive, particularly against the EUR. The RBA minutes released on Tuesday ought to confirm the RBA’s relative hawkishness, and if the JPY also sees some support from the BoJ meeting, the AUD should have potential to see similar gains. EUR/AUD continues to look like the most clear-cut value for the AUD, as there is less chance that risk negative news has a significant positive impact on the EUR against the AUD compared to AUD/USD.