US Dollar, USD/JPY: Prepare for Another Abnormal Week

There has been very little progress towards ending the US government shutdown. This means more data delays and an exacerbated focus on other market events this week, including the FOMC minutes and a slew of G10 central bank speakers. We don’t expect any major breaks in the US dollar, and we wouldn’t chase USD/JPY much higher despite political events

USD: Resilient, but Still Facing Downside Risks

Weekend news suggests very little progress towards ending the US government shutdown, which means further delays in government-issued data. This will probably be another abnormal week in FX, with the pause in most data releases meaning an outsized focus on other macro news.

Federal Reserve pricing for December remains just short of 50bp (46bp this morning), close to the median Dot Plot. The event with the greatest market impact potential is the release of Fed minutes from the September meeting on Wednesday. What we’ll be looking for in the minutes is evidence that Chair Jerome Powell’s cautious view on further cuts is shared by the majority of the FOMC. The risks appear slightly tilted to the dovish side and therefore to a negative USD reaction to the minutes.

In general, the longer the US government shutdown continues, the more the US dollar can face some pressure. But we must also acknowledge that the US dollar has shown decent resilience so far, confirming our perception that markets have considerably raised the bar for how bad US news needs to be to build more USD shorts.

This makes us believe the US dollar may not show much idiosyncratic volatility in the coming days, despite facing downside risks. Domestic stories can instead steer other G10 currencies, as we are seeing happening in Japan today.

Sanae Takaichi’s election as prime minister after a leadership vote is placing the focus firmly on reflationary policy in Japan, which is weakening the yen, steepening the JGB yield curve and sending the Nikkei some 5% higher. Her election was somewhat of a surprise, and the yen’s 2% drop versus USD is a testament to that.

However, we don’t see much more upside for USD/JPY from here. A much weaker yen stands to add to Japan’s cost of living concerns; the rally in USD/JPY could cause friction with Washington, and the yen may still be preferred should the US government shutdown last longer. Our base case is that this break above 150.0 is temporary, rather than the start of a more sustained rally in USD/JPY.

The week will be busy with G10 central bank speakers. Powell will give opening remarks at Thursday’s Fed Community Bank event, where other FOMC members, including Michelle Bowman, are set to speak.

We’ll also hear from the heads of the European Central Bank and the Bank of England (both today), Norges Bank (tomorrow), and the Reserve Bank of Australia (Friday), alongside other Fed speakers throughout the week. On Wednesday, the Reserve Bank of New Zealand announces policy, and we expect a 25bp cut, as per our preview.

EUR: Rangebound Activity May Continue

EUR/USD has struggled to find a catalyst for a big break higher – i.e., above 1.180 – despite some accumulation of negative US news. As discussed above, the bar to sell US dollars appears higher, and the euro is lacking a highly compelling idiosyncratic story.

We could see the pair continuing to stall around current levels, even though the balance of risks remains on the upside due to the US shutdown and potentially dovish Fed minutes. We see a good chance of the pair hovering in the 1.168-1.176 range in the coming days.

Don’t expect much data input from the eurozone this week. ECB speakers will attract more interest, starting with today’s speech by President Christine Lagarde. However, recent inflation figures have simply confirmed that the ECB is fine where it is with rates, so we don’t expect to hear anything new on policy guidance.

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