USD/JPY on the move, as the market eyes up the Fed minutes

The stock market is moving steadily higher and bond yields are trading sideways after a large drop in recent weeks, now is the time for the FX market to make its move. As we move into the final weeks of the year, the dollar is weakening, and that has major ramifications for the FX market and for broader asset prices. USD/JPY dropped by more than 2% last week and is lower again on Monday. It is back below the key 150.00 level, which suggests that we may have seen the peak for the dollar for 2023, and it could continue to grind lower from here. There could be some way for the dollar to fall, USD/JPY is still up more than 13% so far this year, but the dollar index is now flat year to date, as the euro and the pound play catch up. With the yen now doing the same, the dollar is out of favour as we move into the final weeks of the year.

What a rising yen means for Japanese stocks

The USD/JPY rate moves very closely with retail investor sentiment in Japan. Studies have shown that the USD/JPY rate is much more sensitive to domestic retail traders in Japan compared with other G10 FX currencies. The retail FX market is important for the yen, and if Japanese retail FX traders are ditching the dollar in favour of their own domestic currency, then this could have big repercussions on other markets, most notably domestic Japanese stocks. The Nikkei 225, a broad Japanese stock index, rose by nearly 2% last week, and is up by an impressive 29% so far this year and there could be further to go. The Nikkei’s all time high is 39,000, reached back in 1989, currently the index is trading at approx. 33,300, so if momentum is on the upside, then the 39,000 is a key psychological level of resistance that the market may test in the coming weeks. Added to this, if the yen continues to strengthen, then it may attract foreign inflows into Japanese shares, since the returns are more attractive if the yen is rising at a faster pace than other foreign currencies. Key levels too watch in USD/JPY, include 147.50, a support level from mid-September, and then 145.00, which is a psychologically important stepping stone for USD/JPY on the way down to 140.00. Thus, the return of the yen and another leg higher for Japanese equities is a theme that may do well in 2024.

Why a weakening economy may not hurt risk sentiment

A weaker dollar can help to facilitate a risk-on environment, although stocks markets were mixed at the start of this week. US stocks are higher in the futures market ahead of the US open on Monday, and we anticipate that there could be further upside for US stock indices in the weeks leading up to Christmas. Capital flow data is very supportive of further gains for stock markets, and last week inflows into US equity ETFs strongly accelerated, after staying flat for most of the last 6 weeks. This may be a sign that the Santa rally is upon us. There could be an interesting dynamic as we move into the end of the year, the US real economy slows down, just as the US stock market takes off. The Citi Economic Surprise Index has turned lower in the last couple of weeks, as economic data has surprised on the downside. While a strong economy is important, the economy does not mirror the stock market. The US stock market is more reflective of demand for goods, while US GDP is more reflective of demand for services. Thus, even if we see the US economic data turn lower in the coming weeks, it may not spook the stock market.

US Fed minutes and PMI surveys are worth watching

Another driver of the markets this week will be the Fed minutes that are released on Tuesday. The US Thanksgiving holiday is officially on Thursday, but we expect market liquidity to dry up from Wednesday onwards. The key question that investors would like answered from this week’s Fed minutes: are US rates in a peaking process? It is worth noting, that at the last FOMC meeting the Fed chair noted that strong economic data could lead to further interest rate hikes so that the Fed can meet its 2% inflation target. However, since then the data has turned lower, including a lower-than-expected reading for inflation and a weaker than expected retail sales report for October. The market now expects the Fed to cut rates from May next year, if these minutes give further signals of a dovish tilt at the Fed, then we could see another drop in US Treasury yields and more losses for the US dollar. PMI reports are also released for November this week. Expectations are for a moderate improvement in both manufacturing and the service sector PMI surveys; however, the Eurozone composite index is expected remain in contraction territory at 46.9. Germany’s PMI readings could see the largest uptick, which may suggest that Europe’s largest economy is bottoming out, after news last week that Germany’s constitutional Court overruled the government’s planned re-allocation of 60bn euros of unused pandemic era debt to new spending plans for 2024. This court ruling could have far-reaching consequences for fiscal policy in Germany at the same time as the economy is weakening. Germany’s budget deficit was EUR 42.1bn in the first half of 2023, and it could get wider in H2. The German government is now constrained by its own fiscal laws, which could limit any boost from government spending to help the economy to recover. If the German economy remains weak, then it could limit further euro upside. It is also worth watching for any signs that falling inflation levels in Europe have translated into higher levels of consumer spending and service sector PMIs.

UK’s room for tax cuts could boost the pound

The UK is in focus this week with the government’s Autumn Statement coming up on Wednesday. On Tuesday, the latest details on public sector finances will be released. Public sector borrowing is expected to come in lower than the OBR’s forecast, with Reuters expecting UK public sector borrowing for October to be £13.7bn, far lower than the £20.3bn forecast by the OBR. Borrowing between April and September was £81.7bn, vs. forecasts of £101.5bn, thus, the Chancellor has wiggle room, and his focus is expected to be on tax cuts. PM Sunak said on Monday that the time has come to cut taxes, and the details to individual tax savings and potentially cuts to national insurance will come on Wednesday. Inflation has also halved ahead of the government’s deadline of the end of the year, and tax receipts have been higher, so this Autumn statement, compared to the one last year, could be filled in with better news for UK taxpayers. We don’t expect the Autumn statement to have much of an impact on financial markets, although looser fiscal reigns could benefit the pound. GBP/USD is currently attempting to break through $1.25 resistance, if sterling does get a boost on Wednesday combined with further weakness for the dollar, then a move back to $1.30 highs from the summer cannot be ruled out.