Traders are Sitting on a Razor’s Edge

Please attribute the following commentary to Stephen Innes, senior trader at OANDA Asia Pacific

Traders are Sitting on a Razor’s Edge

While focus shifts to the FOMC, the Bank of Japan (BOJ) continues dominating headlines as the guessing game intensifies speculation regarding the size of Prime Minister Shinzo Abe’s fiscal stimulus package.

JPY - Headline to Headline

Yesterday, the USDJPY bubble burst when debate intensified on the back of media reports that stated that Japan’s policy makers planned to inject JPY6 trillion in direct budgetary outlays into the economy over the next few years. While double the amount initially planned, sadly it was shy of the 10-20 trillion anticipated by traders. If there are any a helicopters circling, they are certainly stealthy ones.

USDJPY plumbed to ¥104, but has since recovered as reports are surfacing of growing support within the BOJ ranks for further monetary easing ahead of the two-day policy board meeting, which is set to begin on Thursday.

On the BOJ policy front, the market is expecting at minimum a combination of a deeper move into negative interest rate territory, along with an expansion of the monetary base. As expectations are clearly elevated, we should expect an explosive reaction to any outcome as USDJPY is unlikely to stray from leading this week’s news headlines.

The major downside risk is of perception - since the market has set the bar extremely high for the BOJ, itchy trigger fingers are waiting.

Should the BOJ decide to delay a policy change at the September meeting, I doubt the forward guidance will be enough to sustain current USDJPY levels and we could quickly test ¥103 support. A wave of “risk off” should be expected, which may set the stage for an ultimate test of ¥100. Failing any unanticipated drama, I would anticipate some consolidation to take effect in the ¥104.30 – 105.30 zone, but be weary of headlines.

FOMC - Expect the Unexpected

For the most part, it was a relatively quiet overnight session for risk, which is unsurprising given that summer doldrums are setting in. Along with the proximity to the FOMC, which is materialising into a major event, only the Nikkei moved, falling 1.4% on the back of the strengthening Yen.

With the current market factoring in a 60% probability of one hike in December and potentially two hikes in 2017, the Feds are unlikely to rock the boat. However, this week's FOMC meeting is facing heightened importance due the uptick in US economic data since June’s Non-Farm Payroll announcement. In all likelihood, the Fed may take a cautious stance highlighting Brexit concerns, but there is certainly some scope for the Fed to lean hawkish. Previously, a potential June rate hike was on the agenda. If not for Brexit and an outlier May Non-Farm Payroll, the Fed may very well have pulled the trigger. Since then, employment data has recovered and the US economic prints continue to beat expectations, providing the FOMC with more than enough ammunition to provide some straight forward guidance of an impending rate hike.

Australian Dollar - Significant Risk Event

In a surprising development, the wake of yesterday's USDJPY sell-off inspired a rally on the antipodean currencies.

The move was counterintuitive to the fundamental outlook, especially as both the RBA and RBNZ are more than likely to cut interest rates this month, which left many traders scratching their heads for answers. I can only surmise that given the destitute liquidity density, opportunists took advantage of Yen volatility to put a squeeze on both the AUD and NZD short positions, or more likely, some near-term Aussie shorts felt the strain ahead of today’s unnerving Q2 CPI print and decided to reduce their speculative bets.

The market is headed into today's much anticipated Q2 CPI with huge expectations for a weaker print as a precursor for an RBA Interest rate cut. If the CPI prints top side, I would expect a clearing out of short Aussie positioning and re-exploration of the 0.7650 level.

The previous CPI print was more than ample to convince the RBA that the disinflationary trend is bonafide and was viewed as a policy game changer, so there is much at stake on today's number.

In an environment where the current mantra is ‘expect the unexpected’, dealers are sitting on a razor’s edge this morning, paring Aussie shorts ahead of the CPI print.

UPDATE:

• Australia CPI QoQ for Q2 comes at 0.4% (expected 0.4%)
• Australia CPI YoY comes at 1% (expected 1.1%)
• AUDUSD has rallied higher on the data 0.7550

The Australian dollar has jumped on the better than expected CPI reading. We've seen a wave of weak ‘shorts’ cut, who were hoping for a print below the 0.4% level. While this may add some complications to the RBA narrative, the print still indicates deflationary headwinds and the quick rally may be short lived.

Yuan - Meandering Along

The Yuan continues to firm against the trade-weighted basket on follow through from suspected interventions made before the G-20 meeting in Chengdu. Most traders are waiting for the dust to settle on the Japanese Yen and to get over the FOMC speed bump before re-evaluating the Yuan trade.

Comments from a Professor at PBOC’s Zhengzhou training school that argue that there should be an implicit easing bias, are making the rounds in early trade this morning. The comments are stating that before the G20 summit in September the focus had to be on reassuring market confidence so that internationalisation can begin going forward.

For direct comment, please contact:

Stephen Innes

OANDA

t: +65 6579 8284 m: +65 9176 1384

e:sinnes@oanda.com

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