USD/JPY Drops 1.5% as Yen Rallies on Falling Yields Following Another US GDP Contraction

Key Points

• The yen dominated in currency markets on Thursday, benefitting as US and European bond yields slumped after weak US data.
• The US economy contracted for a second successive quarter, resulting in a further paring of Fed tightening bets.
• EUR/USD was flat in the mid-1.0100s despite hotter-than-expected German inflation figures for July.

Yen Dominates As Bond Yields Pullback Post-weak US GDP Data

The Japanese yen was the standout performer in currency markets on Thursday, with the rate-differential sensitive currency benefitting from a substantial drop in US and European bond yields after data showed the US economy contracting for a second successive quarter in Q2, and amid ongoing concerns about the impact of the energy crisis on the European economy.

US 10-year yields fell nearly 10 bps to fresh three-month lows on Thursday under 2.70% after data showed that the US economy contracted at an annualized pace of 0.9% in Q2 after shrinking at a pace of 1.6% in Q1. The drop in bond yields reflected investors paring back on their expectations for Fed hawkishness in the coming quarters as the reality of weak US growth bites.

Fed funds futures markets are now priced for the Fed’s benchmark interest rate to peak this December at just 3.24%, less than 100 bps above current levels. On Monday, prior to the Fed’s “dovish” 75 bps rate hike on Wednesday and Thursday’s ugly growth figures, money markets were priced for rates peaking at 3.39% next February.

The difference between US 10-year yield and the Japanese 10-year yield fell under 250 bps on Thursday, down from nearly 280 bps at the start of the month. This has helped pressure USD/JPY, which was last around 1.5% lower on Thursday and eyeing a test of its 50-Day Moving Average in the 134.10 area, having earlier dropped under 134.50 for the first time since late June.

The yen is sensitive to long-term rate differentials because the BoJ has a policy of keeping Japanese 10-year yields anchored at no more than 25 bps away from zero. A narrowing of the rate differential increases the yen’s relative attractiveness as a place to park money.

Analysts suspect that if markets continue to push long-term US yields lower as then further moderate Fed tightening bets/US growth expectations, the recent USD/JPY drop could have further to go.

Euro Ignores Hot German Inflation Figures as Growth Fears Dominate

EUR/USD was flat on Thursday, with traders reluctant to sell the US dollar against the euro given the prevailing mindset that, yes, the economy in the US is suffering and Fed tightening bets are being wound down, but things are even worse in the Eurozone. Earlier this week, Russia stoked European energy crisis fears after it reduced gas flows to Germany via the Nord Stream 1 pipeline, widely seen as a retaliatory move over the EU’s support for Ukraine.

The pair was last trading roughly flat on the day having chopped between the 1.0100 and 1.0200 levels, with hotter-than-expected German inflation figures according to a preliminary July release unable to turn sentiment in favour of the euro. The kiwi, Canadian dollar and pound were all broadly unchanged versus the US dollar as well, with the DXY holding in the mid-1.0600s. The Aussie was a modest underperformer amid concerns about global growth.

Friday’s Macro Risk Events

Looking ahead, data on Friday will further inform investor expectations regarding the US economy and Fed policy. US PCE Price Index figures for June will be released and are likely to show that core price pressures remain below their peak hit earlier this year.

Employment Cost Index data for Q2 is likely to show a slight deceleration in the pace of wage gains, which should ease Fed concerns about the tight US labor market’s contribution to current elevated inflation. Meanwhile, Personal Income and Spending growth figures for June will give an update as to the health of the consumer at the end of Q2.

Outside of the US, the Eurozone inflation story will receive further inputs with the release of French, Spanish and then Eurozone aggregate July figures on Friday.