Low Vol Environment Continues

US jobs numbers continue to cause ripples in a becalmed summer FX market. Expect more of the same today as the market focuses on the weekly initial claims ahead of tonight big NFP report.

USD: Thrashing around in a low vol environment.

The US secondary employment data (JOLTS and ADP) have contributed to a slight weakening of the dollar this week. Nonetheless, these figures have not yet provided definitive evidence that could signal the conclusion of the Federal Reserve's hawkish position. A significant shift in trends will only materialize if the August NFP job data, set to be released tonight, displays a substantial downside deviation. Such an outcome, coupled with a substantial drop in the unemployment rate, would challenge the notion that robust job market conditions could maintain the Federal Reserve's hawkish stance for a longer period than commonly anticipated.

In the current context, attention will once again be directed towards secondary and tertiary employment indicators, including the weekly initial claims data. Additionally, key economic indicators for July, such as personal income, spending, and the core PCE deflator, are scheduled for release. Market consensus suggests a marginal increase in the core PCE deflator to 4.2% year-on-year from the previous 4.1%. Consequently, this development is unlikely to prompt a significant influx of positions against the dollar. Broadly speaking, market volatility across various asset classes remains subdued, and there is little rationale to contest the appeal of engaging in carry trades funded by the Japanese yen or Chinese renminbi.

As previously mentioned, the presence of overnight rates at 5.30% supports the dollar's ability to maintain gains within a carry trade framework. Currencies exhibiting noteworthy performance continue to be the emerging market high yielders, particularly those originating from the CEE3 region and Latin America (Latam). The Mexican peso sustains its upward trajectory and presents an enticing implied yield of approximately 12%. Moreover, the peso stands to benefit from recent statements by Banxico indicating a lack of intention to implement rate cuts soon, setting it apart from the trajectories pursued by Brazil and Chile. Unless there is a sudden and pronounced surge in the NFP data today, it is plausible that the DXY index will remain within a range of 103.00 to 103.50.

JPY: Where is the alarm?

The USD/JPY currency pair has gradually moved within the 145-150 range associated with potential intervention, yet this movement hasn't caused significant concern in Tokyo. A notable contrast between the present situation and the intervention phase from last September and October is the higher level of orderliness in the foreign exchange markets. To illustrate, the implied volatility for USD/JPY over a one-month period stands at approximately 9% today, which is notably lower compared to the 14-15% range observed during Japan's FX intervention last year.

Furthermore, there isn't a discernible emergence of a 'sell Japan' sentiment, and Japanese authorities might accept a weaker yen given the deflationary pressures emanating from China, as well as the subdued conditions in export markets across Asia and Europe. Unless a significant financial disruption occurs, leading to an unwinding of the carry trade, it seems likely that the USD/JPY exchange rate can remain within the 145/150 range for a longer duration than initially anticipated. A substantial downward shift could potentially materialize closer to the late September and October timeframe, coinciding with the accumulation of more substantial evidence pointing toward a slowdown in the United States. This period might also witness heightened speculation about potential policy adjustments by the Bank of Japan, which could influence the currency dynamics.

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