There are murmurs of a stagflation environment developing in the US after the 1Q2024 US GDP results slowed to 1.6%, down from 3.4%, while the US Personal Consumption Expenditure (PCE) price index for March climbed to 2.7%, up from 2.5% in February. Stagflation is an environment where there is slow economic growth accompanied by high unemployment and inflation. There was however strong risk on trade flows at the back end of the week despite the negative data prints from the US which allowed global equities as well as the rand some room for recovery.
The week ahead will focus on the latest Federal Open Market Committee (FOMC) statement from the Fed and the state of the US labour market with the release of the latest US non-farm payroll print for April. As things stand markets have reduced their bets for a Fed rate cut in June and the latest FOMC statement will hopefully provide more clarity on the expected rate path from the Fed. One thing is certain, pressure is building in the macroeconomic environment, particularly in the East.
The Japanese Yen fell to a 34-year low against the dollar last week after the Bank of Japan (BoJ) opted against further tightening of monetary policy. The BoJ is trying to facilitate supportive financial conditions with its decision to maintain its benchmark rate between zero and 0.1%. It may however only be a matter of time before the Bank of Japan will be forced to intervene in the foreign exchange markets to rescue the yen. The yen is a particularly important domino in the current financial system since it is the carry trade currency of choice and Japan is also the biggest holder of US treasuries with roughly $1,500 billion US treasuries on their books. Intervention methods to save the yen will either be to sell off US treasuries or increase interest, both of which cause the carry trade margin to decrease which will severely rattle the foundations of the financial system.
The first chart of the week is the USDJPY. The divergence between the BoJ monetary policy and the rest of the major central banks has pushed the Yen to multi-decade lows as it placed increased selling pressure on the currency. The yen has now depreciated roughly 22% since the start of 2023 and further weakness is expected unless either the Fed starts dropping interest rates or the BoJ starts hiking rates. The carry trade has been an exceptionally profitable one since the inception of casino capitalism as it allows investors to borrow (sell the yen) at 0% interest and then re-invest those borrowed funds into higher-yielding bonds. This system is however showing signs of fragility and FX intervention from Japan may just close the buffet on this free lunch.
The other integral part of the financial system is the US treasury market. The US 10-year yield is showing signs of pulling back following the strong selling pressure since March. US yields tumbled in the early morning session on Monday while the USDJPY dropped aggressively to a low of 154.56. We’ll be keeping a hawk’s eye on yields given the volatility on the USDJPY pair. A failed break below 4.50% will allow the US 10-year to return to the 2023 high of 5%.
The DXY is pulling back ahead of the FOMC statement and the US non-farm payrolls. The key support levels to watch are at 105.11 and 104.77. A failed break below this support range will allow the DXY to climb back to the 2023 high of 107.35
The rand managed to stage an impressive recovery last week off the back of the increased risk on investor sentiment which allowed the rand to pull the pair below the 50-day and 200-day MA support rates. I did not expect the rand to pull the pair onto the upward blue trend line but the month-end flows helped nudge the rand a further than expected. I still however believe that this is a temporary pullback for the pair. A failed break below the upward blue trend line and the support at 18.68 will see the pair re-test the critical rate of 18.97. The pair is currently being squeezed by this blue wedge and I still favor a top-side break over a downside break. A break above the critical rate of 18.97 will be an early indication of a top-side break of the wedge. A break below 18.68 will however invalidate the expected price action in the chart below.
Brent crude oil has caught strong support off the 50-day MA of $85.50 pb and the move towards $93.40 pb is now firmly on the cards.
