FX: Abenomics 2.0 to the rescue

Equity markets continue to perform well. Growth trends remain supportive, and some modest progress on US tax reform and continuity in Japan politics is also helping. The question this week is what happens to US bond yields? For 3Q17 GDP this Friday, we are above consensus.

We think risks look skewed to the upside here. Be it the positive re-assessment of the US tax reform, suggestions of hawkish John Taylor making it to the Fed or indeed higher Bund yields unlocking the upside for Treasury yields. The majors would prefer to express dollar strength against the JPY and DXY could challenge 94.25.

EUR/USD has held up quite well so far given the continued widening in short-dated interest rate spreads and uncertainty in Spain. The big story this week will be Thursday’s ECB meeting, where we look for a bigger cut in ECB tapering – from €60bn to €20-25bn per month – which should trigger a one-off jump in EUR/USD. That could see the EUR/USD back to 1.20, but it may have to weather some downside first. Below 1.1730 and risks 1.1670.

Unlike Theresa May, Shinzo Abe’s call for a snap election has paid off, delivering his Liberal Democrat Party (LDP) party two-thirds super-majority in the Lower House. This will allow him to push ahead with the policy agenda of another consumption tax hike in 2019 and potential reforms to the Constitution.

The big win suggests another round of Abenomics, including the likelihood that Kuroda extends his term as Bank of Japan Governor when it ends in April. With the prospect of US tax reform marginally improving, this looks a pretty bullish environment for USD/JPY. Today’s dip in USD/JPY may be shallow – just filling the gap to 113.50 left in Asia, before a test of some good resistance at 114.50.

Despite the meaningful victory of the non-traditional and to a degree populist parties in the Czech parliamentary elections over the weekend, we expect a muted and short-term impact on Czech financial markets, even if the seeming differences between the parties led to early elections. Historically, Czech elections have had limited impact on the Czech Koruna and this time should be no different.

The Czech National Bank (CNB) should remain hawkish given the signs of an overheated economy and the very tight labour market. The more hawkish pace of CNB hikes (compared with what is priced in) coupled with the normalising EUR/CZK forward curve should continue to put gradual downside pressure on EUR/CZK.