The world’s largest central banks created a tremendously turbulent week in the financial markets last week. Volatility popped through the roof on Wednesday after the Federal Reserve’s (Fed) decision to raise the federal funds rate by 25 basis points to 5.50%. Thereafter the European Central Bank (ECB) followed in lockstep to also raise their interest rates by 25 basis points to 4.25%. Both these rate hikes were widely expected thus the rate hikes weren’t the events that rocked volatility. We need to turn our attention eastward to the Bank of Japan (BOJ) to find the source of volatility.
On Thursday the BOJ revealed that it would keep their rates at -0.1% and keep their 10-year Japanese government bonds’ (JGB) yield target at 0%. The Japanese bond market survives off a policy called yield curve control. What this entails is that the BOJ is an active bond market participant and serves as the buyer of last resort in the bond market. By participating in the bond market, the BOJ can manipulate the yield on the JGB’s. As of December 2022, the BOJ held 52% of outstanding JGB’s. This approach is dramatically different from the Federal Reserve’s typical way of managing US economic growth and inflation, which is by setting a key short-term interest rate, the federal funds rate.
The BOJ announced that it would conduct yield curve control “with greater flexibility.” What this means is that the BOJ will allow yields to rise as high as 1.0%, roughly 100 basis points above the target rate of 0%. The BOJ will then have a hard stop to buy all the bonds that are for sale in order to suppress the bond yields. There are many critics against yield curve control, including myself, and the reviewed policy by the BOJ will do little to reverse Japan’s inflation problem but will do everything to spark another bond market crisis…
The headlining event for this week is undoubtedly the US non-farm payrolls report. The recent soft inflation data from the US and stronger than expected US GDP results for the 2Q2023 which came in at 2.4%, quarter-on-quarter, has supported the Fed’s “soft landing” narrative. The “soft landing” entails that the Fed will be able to cool US inflation to 2% without creating a recession thus Friday’s US employment figures will be closely watched to judge the state of the US labour market. Additionally, the Fed also stated last week that they expect the US economy will avoid their previously forecasted “mild recession.” In terms of rate decisions, the Bank of England will take a baton from the Fed and ECB this week. The BOE is also expected to raise their rates by 25 basis points which will push their rates to 5.25%
To kick-off this week’s chart pack is the DXY. The dollar punished the major currencies following the Fed’s rate hike, strong GDP results and lower than expected inflation figures. The tumbling Japanese Yen also pushed demand for the dollar. The key resistance level to watch is the 61.8% Fibonacci retracement rate of 102.023. A break above this level will allow the DXY to test its 50-day MA rate of 102.542. Things are looking increasingly bullish for the dollar, and I suspect the DXY will break above the 50-day MA and push higher and test the 200-day MA rate of 103.788 over the next couple of weeks. The technical indicators are also supportive of a move higher for the DXY with the daily MACD indicator holding a strong buy-signal.
Turning our attention to the US bond market and specifically the US 10-year yield it looks like bonds could get battered this quarter. Remember, when bond yields rise, the price of the bond drops and vice versa. The US 10-year yield spiked on Thursday after the volatility wave sparked a bond sell-off which pushed the yield climb above 4.00%. If US 10-year yields fail to break back below 3.92% it could ignite a move higher towards the 2022 high of 4.328%. The 50-day MA yield of 3.80% also serves as a strong support level.
I honestly did not expect the rand to pull the USDZAR pair below 18.00 given the strength of the broad-based dollar strength against the major currencies last week. The correlation between the DXY and the USDZAR has clearly weakened, and this is attributable solely to the rand’s strength. The rand fell on the backfoot on Thursday but a failed break above the 200-day MA rate of 18.00 allowed the rand to pull the pair to a weekly close just under 17.60. The 200-day MA rate of 18.00 is the main resistance level to watch and the rand looks to have the psychological rate of 17.00 firmly in its sights. The technical indicators are however suggestive of a highly oversold USDZAR pair which could allow for a minor pullback. Remember markets don’t move in a straight line. To wrap it up neatly, as long as the rand can hold the pair below 18.00, expect further rand appreciation.
The crucial factor which is supporting commodity currencies such as the rand, is the oil price. Crude oil made another strong push higher last week which allowed the price per barrel to break above the 200-day MA resistance rate of $81.63 per barrel (pb). A break above the 23.6% Fibonacci retracement rate of $84.78 pb will allow the price per barrel to climb higher towards $93.62 pb. Commodity bulls are frothing at this move since it will pull other commodities higher. I’m however expecting a re-test of the 200-day MA this week as the rate swings from a resistance to a support level.
