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Summary
- After last week’s US jobs report and yesterday’s CPI data, US yields have exploded higher and have made new year-to-date (YTD) highs across the curve.
- USD/JPY has also accelerated quickly, closing above 152 for the first time in TKTK years, which greatly increases the probability of JPY intervention by the Japanese Ministry of Finance (MoF).
Market Implications
- We would not chase US yields higher at current levels, and would prefer to fade the recent up move, preferring to scale-in to a received position in the short end.
- After a spate of verbal pushback against JPY weakness in recent weeks, we think there is an elevated probability the MoF intervenes in the market to buy JPY.
- We therefore prefer to stand aside in USD/JPY, although downside looks more likely than upside.
US Yields Continue Their March Higher
Last week’s strong US jobs report was followed by across-the-board beats in US CPI yesterday.
This has lifted 2-year and 10-year US yields considerably higher.
Since we wrote our piece last week outlining our caution on the US rates market, the 2-year yield is ~30bps higher. Since printing its YTD low in early January, the 2-year yield is up about 85bps.
The 2-year yield now trades at levels not seen since November.
Chart 1: Orange Line = 2-Year US Yield
The 10-year yield has also accelerated higher over similar time periods – it is up ~25bps since this time last week, ~75bps since printing its YTD low in early February and is also back at levels not seen since November.
Chart 2: Orange Line = 10-Year US Yield
US Yields Are Becoming Stretched, Especially the Short End
This seemingly inexorable sell-off in the US rates market has taken yields to the November highs, which were previously seen during the Global Financial Crisis (GFC).
The move higher in yields has been short and sharp and, while not moving in a straight line, the trend has been strong and only seen short-lived, episodic corrections.
We think the move in the short end (proxied by the 2-year US treasury yield) appears stretched.
There has been so much easing priced out of Federal Reserve (Fed) expectations that the risk/reward now favours fading the move higher in short-end yields.
That is not to say we want to go all in at current levels and play for an immediate drop in yields.
However, we like scaling-in to a long position between the current 2-year level (~4.96%) and the high seen in October (~5.25%).
Picking a top in yields is a fool’s errand, which is why we like building this exposure in tranches.
The ~5.25% yield point is a good level to lean on. If we are wrong, and the market continues to price out the residual Fed easing that remains priced for 2024, then 5.25% gets taken out.
However, if our instincts are correct this looks like a good level to scale into a long position, playing for lower US short-end yields.
The USD Is Also Flying High
As we wrote last week, the higher US yields outlined above have been a major contributing factor to the USD rising steadily in 2024.
The DXY printed its YTD high yesterday and, like US yields, is at its strongest level since November.
Chart 3: Orange Line = USD Index Spot Price
While this index tells its own story of broad-based USD strength, the most interesting price action has been in USD/JPY.
Following the hot CPI print yesterday, USD/JPY settled above 153 for the first time in over 30 years. The pair is up about 8% YTD.
Chart 4: Orange Line = USD/JPY Spot Price
We Remain Wary of Being Long USD/JPY
Given the support from the US interest rate market, not to mention a strong US economy relative to the rest-of-the-world, it is tempting to think additional USD upside beckons.
After all, the pro-USD interest rate differentials/carry have been a big driver of USD/JPY upside this year.
And even though many commentators think those differentials can continue to widen in the USD’s favour, we are less sure.
As we outlined above, the US short end is at or near levels where a reversal lower in yields is becoming more likely. This should weigh on the USD, or at least be less of a dollar tailwind.
More importantly, as we argued a couple of weeks ago, the multi-decade high in USD/JPY greatly increases the likelihood that the MoF buys JPY in the market to push back against yen weakness.
The MoF has been verbally intervening for several weeks now, including this week.
Given the frequency of and strong language employed by the MoF in these interventions, we think it is a question of when, not if, they start buying JPY in the market.
As such, we think the risk/reward of being long USD/JPY at current levels is unattractive.
And, if we are right about US short-end yields, and the MoF does intervene, it will open material downside in USD/JPY.