The yen launches a counterattack

• USDJPY pulled back as the bond sell-off paused.
• The dollar remains strong due to the high likelihood of further Fed rate rises.

The dollar index took a step back as the sell-off in Treasuries eased and oil prices retreated. Brent fell below $100 per barrel on rumours that the US and Iran are exploring a phased deal that would lead to the reopening of the Strait of Hormuz. Given the record correlation between oil and debt market rates, the pullback in yields and the USD index appears logical.

Nevertheless, the greenback remains strong. The futures market is pricing in a 70% probability of a Fed rate rise in October, compared with a 50% chance for the ECB.

Investors believe that rising Fed rates are slowing the US economy less than in the past. If so, bringing inflation back to the 2% target will be more difficult, requiring a more aggressive or prolonged tightening cycle. Investors are gradually coming round to this view, laying a solid foundation for the US dollar’s rise. Shortly after the FOMC meeting, derivatives markets were pricing in a 75-basis-point rate hike over the next 12 months, whereas they now indicate a 50% chance of a 100-basis-point increase.

The pullback in Treasury yields and the US dollar has allowed the bears on USDJPY to launch a counterattack, more so given that Donald Trump, at a meeting with Sanae Takaichi, expressed concern about the weakening of the yen. This heightens the risk of another coordinated currency intervention by Washington and Tokyo and is keeping speculators on edge. The Japanese government believes that the era of Abenomics-style reflationary policy has come to an end. The current situation calls for higher interest rates and flexible fiscal policy.

The pound received a boost from a rise in support for Andy Burnham’s party. A YouGov poll showed that, if an election were held today, Labour would win the most seats in Parliament. The Conservatives came second, whilst Nigel Farage’s Reform UK slipped to third. Nevertheless, gains by the GBPUSD bulls appear modest. They are being held back by the risks of a resurgence of the energy crisis in Europe and problems arising from the new government’s budget.

The FxPro Analyst Team