Reflation trade unwind boosting JPY and EUR – SocGen

Alvin T. Tan, Research Analyst at Societe Generale, points out that apart from the sterling outlier, typical safe haven currencies such as JPY and EUR have outperformed the usual high-beta crowd of AUD and NZD notwithstanding buoyant equity markets since the peak in US bond yields in mid-March

Key Quotes

“The proximate reason for this is that JPY and EUR continue to be driven by the direction of US real bond yields, and lower yields have benefitted them, while weaker commodity prices, namely crude oil and iron ore, have dragged the likes of AUD and CAD lower. At a more fundamental level, it showcases the point that it is still US data flow and policies that dominate the medium-term direction of EUR/USD and USD/JPY. Thus, a weakening of the US reflation thesis (and lower US real yields) has seen these two major currencies strengthen.”

“This disproportionate impact is unlikely to fade until the ECB and BoJ shift towards policy normalisation. We are highly doubtful that any such move is forthcoming from the BoJ this year, but a shift by the ECB is expected in 2H17. The acceleration of ECB excess liquidity might have contributed to lulling European real yields into sleep in recent quarters, and a reversal of that could spur a return of more volatility. We could consequently see the dominance of US real yields on EUR/USD diminish if the ECB were to start tapering its asset purchases. Until then, US yields and Fed expectations will continue to dominate the price action in these two currencies.”