Dollar retreats ahead of Biden-Trump debate

Dollar Retreats Ahead of Biden-Trump Debate: Calibrating Intervention Risks

George Vessey – Lead FX Strategist

The Japanese yen, constituting nearly 14% of the US dollar index, is in the spotlight. USD/JPY surged above ¥160 yesterday, reaching its highest point since 1986, raising concerns about potential intervention. The last time this level was briefly breached in late April, the Bank of Japan (BoJ) likely intervened, resulting in a 1.3% drop in USD/JPY by the end of the day. This time, however, the situation might be different.

The risk of intervention appears lower due to a more controlled JPY depreciation and overall subdued FX volatility. One-week realized volatility in USD/JPY is around 4.50%, much lower than the levels that typically prompt Japanese officials to intervene. Nonetheless, Japan’s currency chief, Masato Kanda, emphasized the high urgency with which authorities are monitoring the markets, ready to take appropriate actions as needed. Even if the BoJ decides to sell dollars, any pullback in the currency pair might be less significant compared to previous interventions, as evidenced by options market pricing, which shows one-week risk reversals at their least bearish for the USD in three months, indicating no immediate rush to hedge against an intervention-triggered drop.

In June, the yen has fallen by about 1.5% against the dollar, extending the year-to-date loss to approximately 13%, driven by the monetary policy divergence between the BoJ and the Federal Reserve. The dollar index climbed to 105.8 on Wednesday, a two-month high, as traders assess the monetary outlook while digesting Fed officials’ comments and anticipating the key PCE inflation report on Friday.

Mixed Data Complicates BoE Outlook

George Vessey – Lead FX Strategist

The pound has strengthened across the board this morning as data from Indeed showed that British companies increased wages at the fastest pace since January in job postings. This development could complicate the case for an interest rate cut by the Bank of England (BoE) in August.

Advertised pay on Indeed rose by 6.5% in the year to May. While part of this increase is due to a 9.8% jump in the minimum wage in April, it also reflects worker shortages since the pandemic. These figures offer a more current snapshot of labor market trends, which the BoE is closely monitoring for signs of upward pressure on prices. Policymakers have indicated that wage growth remains too rapid to align with the UK’s 2% inflation target, potentially keeping borrowing costs at a 16-year high for a bit longer. Despite today’s data and persistent core and services inflation complicating the outlook, we believe the BoE is more likely to cut rates in August. The UK election will be over, economic activity is slowing, and consumer spending is weakening, as evidenced by the weaker-than-expected monthly retail sales balance from the Confederation of British Industry (CBI) yesterday.

Currently, in this low volatility environment, the pound remains an attractive currency due to its high yield advantage, particularly against the EUR, JPY, and CHF. For GBP/USD, the pair remains above $1.26 but has fallen below its 50- and 100-day moving averages, indicating potential further downside.

Risk-Off Mood Limits Euro Recovery

Ruta Prieskienyte – Lead FX Strategist

The euro weakened to a near two-month low at $1.0687 after ECB Governing Council member Rehn suggested a bias towards additional easing this year. Deteriorating risk sentiment led to declines in European equities and higher European government bond yield curves, in line with global trends. The OAT-Bund spread increased to 76.8bps, adding further pressure to the euro.

The euro was already under pressure early Wednesday due to an unexpected drop in German consumer morale, the first decline in five months. The GfK Consumer Climate Indicator fell to -21.8 for July, down from -21.0, missing market expectations of -18.9. Both income expectations and economic prospects were lower, leading to increased saving tendencies and depressed buying propensity. This report marks the third survey this month falling short of expectations, indicating a challenging path to recovery. Despite these headwinds, we still expect the German economy to avoid stagflationary conditions in the second half of the year.

Across the FX market, the Japanese yen weakened to a record level of 171.60 against the euro, raising fresh concerns about potential intervention by Japanese authorities to support its struggling currency. Today’s US jobless claims numbers and the US presidential debate could influence markets ahead of Friday’s PCE report and the French election vote on Sunday. As the week progresses, EUR/USD is trading at the lower end of its one-month range. With short-term risks tilted to the downside, continued euro weakness could see EUR/USD testing the April lows around $1.0620.