Good morning. Oil benchmarks are recouping some of yesterday’s losses and the dollar is advancing narrowly, with long-end Treasury yields creeping up and equity futures pointing to modest gains at the open. The euro, pound and Canadian dollar are also edging higher in rangebound trading.
The geopolitical picture remains unclear. President Trump yesterday claimed talks with Tehran were under way, warning of a “last chance” to sign a deal, but Iran’s foreign ministry said no negotiations were taking place and no meetings were scheduled. “I want to give them every last chance before decapitation,” Trump later told reporters, adding “you’ll find out today or tomorrow. I mean, they’re going to go quickly, one way or the other. It’s not very complex”. At least one cargo ship was struck by a projectile overnight, a US military base in Kuwait came under attack, and shipping volumes through the Strait of Hormuz and Bab el-Mandeb remain far below pre-war levels. Punters in prediction markets are growing sceptical of a full normalisation this year.
The dollar remains near a three-week low after Chair Kevin Warsh’s performance during last week’s Federal Reserve press conference left markets grappling with credibility concerns. Warsh offered little explanation for keeping rates unchanged, hinted that rising bond yields were tightening financial conditions on the Fed’s behalf, and cast doubt on the continued use of the core personal consumption expenditures index as the committee’s principal inflation measure. The market’s verdict was swift: odds on a September hike fell from near certainty to less than 65%, long-term rates rose, equities fell, and the dollar dropped—a combination that suggests investors doubt the Fed’s willingness to act, and are pricing in a higher uncertainty premium to compensate.
This week’s US labour-market data could bring further uncertainty. Today’s June job openings report, tomorrow’s ADP private-sector hiring figures, and Thursday’s jobless claims will set the stage for Friday’s July non-farm payrolls report, which is expected to show 86,000 jobs added alongside a modest rise in the unemployment rate. June’s print of just 57,000, roughly half the consensus forecast, dragged the three-month average down to 111,300 and left markets expecting a rebound. An in-line reading should leave Fed expectations broadly unchanged, but July payrolls have produced some of the biggest surprises in recent years and are often accompanied by deep revisions to prior months—a combination that could trigger another bout of volatility.
The yen is holding near 157 to the dollar, up from a four-decade low of almost 164, after America joined Japan in intervening in the currency markets on Friday. Having already burned through $70bn in April and May, Japan appears to have deployed a further $100bn or so in the latest round; Treasury Secretary Scott Bessent was photographed with a to-do list* that included buying $5bn-10bn of yen. Both governments have promised to act again as needed.
Whether the intervention proves durable is another question. Shorting the yen has become costlier and more dangerous, and the history is encouraging: each of the three episodes of co-ordinated US-Japanese intervention since the mid-1990s reversed the currency’s direction, at least for a time. Joint action carries a credibility that solo efforts lack. But $5bn to $10bn, while a significant sum to deploy on a holiday-thinned Friday afternoon, pales against the $7.5trn that changes hands in the currency markets each day. The yen is about 4% stronger than a week ago, but still sits above the 155 mark that has tripped up previous campaigns—and neither speculative positioning nor the carry trade currently look big enough to make a squeeze self-sustaining**.
Some believe that tighter monetary policy from the Bank of Japan could ride to the rescue, putting the correction on a firmer fundamental footing. But the gap is wide. With Japanese policymakers committed to gradual normalisation and the Federal Reserve expected to resume tightening in the autumn, two-year rates remain roughly 2.7 percentage points higher in America than in Japan. A common worry is that the Bank cannot raise rates without imperilling the government’s finances: public debt runs to some 230% of gross domestic product, the highest in the rich world. Yet that debt is mostly owned at home, and Japan is a huge net creditor to the rest of the world, with its claims on foreign assets dwarfing foreigners’ claims on its own. Instead, the Bank, we suspect, is willing to tolerate inflation running a little above target as it tries to escape a decades-long growth slump—and is comfortable with a modest steepening in yield curves that puts long-term rates close to Germany’s. A rapid acceleration in the pace of rate hikes looks unlikely.
Currency headwinds, in other words, are likely to persist. For decades Japanese investors have parked their savings abroad, lured by higher yields and brighter growth. That structural outflow has steadily dragged the yen down, and intervention alone cannot reverse it. A lasting recovery would require the underlying flows to change—through narrower rate differentials, stronger growth at home or a shock to the outperformance in US markets that keeps drawing Japanese money out. Until then the currency may well drift back towards weakness.
The more intriguing question is what is driving America. Both Bessent and Trump have framed the action as a favour to an ally. But the administration also seems anxious about the jump in Treasury yields that could follow if Japan sold American government bonds to raise dollars, piling supply onto a market already strained by fiscal worries and doubts about Fed policy. Stepping in alongside Tokyo lessens the need for such sales****. Bessent hinted as much by publicly pressing the Fed to expand its FIMA***** repo facility, which lets foreign central banks raise dollars by pledging Treasurys as collateral rather than dumping them; Katayama, Japan’s finance minister, said yesterday that Tokyo intended to use it. The Treasury, it is reported, also bought yen with euros rather than selling dollars—a manoeuvre, we think, meant to help Japan without feeding the widespread suspicion that the administration wants a weaker greenback. In the end, Friday’s intervention may have exposed American sensitivities more than Japanese ones.
*I suspect the note was intended to act as reminder to raise the topic during Friday’s Cabinet meeting. But that it reads more like a shopping list given to an absent-minded husband is very, very funny. One hopes he remembered to pick up the milk as well.
**The precedent from October’s intervention in the Argentine peso is instructive. The US backstop succeeded in helping to halt a sharp slide, but the peso has since depreciated back to pre-intervention levels***.
***Nobel Prize-winning economist Simon Kuznets famously said “There are four kinds of countries in the world: developed countries, underdeveloped countries, Japan, and Argentina”.
****This is reminiscent of discussions earlier this year over extending dollar swap lines to Gulf countries affected by the Iran war. It was not immediately obvious why countries with vast dollar holdings would need such facilities, but the rationale soon became clear: the US simply did not want them selling Treasurys.
*****The Foreign and International Monetary Authorities repo facility, launched by the Fed in March 2020, allows foreign central banks to swap their Treasury holdings temporarily for dollars on an overnight basis. This helps underpin the global dollar system by safely providing liquidity on demand and removing the need for “fire sales” in which institutions outside the US are forced to offload bonds on the open market during a crisis.