Hawkish Vibes From Asia

USD: BoJ and PBOC drive dollar lower

This morning, the relentless surge of the US dollar is facing resistance from two currencies that had, until now, essentially contributed to strengthening the USD: the yen and the yuan. In an interview, Bank of Japan's Governor Kazuo Ueda hinted that policymakers might gather enough information by year-end, especially if wage inflation persists, to consider scaling back some of the monetary stimulus measures. This development has triggered a notable market reaction. The overbought USD/JPY pair is declining and testing the 146.00 level, while benchmark JGB yields stand at 0.70%, despite the BoJ's deployment of the loans-for-bonds program to control yields. Ueda's interview timing appears to suggest an intent to support the JPY without resorting to intervention, which might not be warranted given the current rate of JPY depreciation.

Meanwhile, in China, authorities have adopted robust measures to defend the renminbi after last week's growing consensus that the People's Bank of China was becoming more tolerant of CNY depreciation, as USD/CNY had risen above 7.30. Alongside a considerably stronger CNY fixing, the PBoC issued a statement urging market participants to "voluntarily maintain a stable market" and avoid speculative trading. The general weakening of USD momentum this morning has helped push USD/CNY back below 7.30.

This shift in dollar dynamics has been driven by actions from the BoJ and PBoC, but whether USD/JPY and USD/CNY will remain under pressure depends on how the dollar responds to its own domestic drivers. The upcoming week is poised to be busy in terms of US data releases, and recent releases have generally supported the greenback.

The highlight of the US calendar this week is the CPI report scheduled for Wednesday, which is widely anticipated to reveal an increase in August inflation. Our economics team suggests potential upside risks to consensus expectations. The core CPI print is expected to show a 0.3% month-on-month acceleration, compared to the 0.2% MoM seen in recent months. There are no data releases to watch today, but later this week, we'll see the NFIB survey, retail sales, and industrial production figures from the US.

The FOMC has already entered the pre-meeting blackout period, but recent indications strongly point to a pause in September. Could inflation alter policymakers' decisions? It would likely require a significantly stronger-than-expected inflation reading. From a foreign exchange perspective, expect the dollar to still feel the bullish impact, as markets can potentially add to the 11 basis points of tightening by year-end and delay rate cut expectations. The two-year USD swap rate (OIS) may retest the highs of 4.94% seen in August, countering efforts by the PBoC (likely to be ongoing) and the BoJ (probably a one-off move by Ueda) to boost their respective domestic currencies.

EUR: Some support before the ECB

It's ECB week in the Eurozone, and there's a growing sentiment that this decision will be highly contentious. The governing council is clearly divided as some signs of persistent inflation clash with evidence of an economic slowdown, which has recently bolstered the dovish stance. ING economics team believes that, while it's a closely contested decision, the European Central Bank should proceed with one final 25 basis point hike. Market pricing currently anticipates a 10-basis point increase before the meeting and a total of 18 basis points of tightening by January. Nevertheless, I believe the likelihood of the ECB postponing this meeting and opting for a hike later is relatively low, considering the rapidly deteriorating economic outlook.

EUR/USD has received a boost from the actions of the PBoC and BoJ, resulting in a softening of the USD and EUR/USD finding support in the 1.0700/1.0750 range. The pair may continue to find support today due to the absence of significant data releases, but I've observed signs of speculative EUR positions unwinding in anticipation of the ECB meeting. Given the potential upside risks for the dollar leading up to the US CPI release, I suspect that another drop below 1.0700 before the ECB announcement on Thursday is quite plausible.

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