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Jan 20 (Reuters) – EUR/USD traded lower Friday as US rate gains underpinned the dollar but price action suggests higher levels are likely as Federal Reserve rhetoric isn’t scaring away longs.

Fed vice chair Lael Brainard said Thursday the central bank is still probing for interest levels adequate to tame inflation.

Her comments helped drive US rates and yields up, but dollar gains have been minimal which suggests investors may not be taking them to heart. Eurodollar futures pricing suggests Fed rates cuts will be made sometime in the second half of, which likely hinders dollar gains.

European Central Bank President Christine Lagarde on Thursday pushed back against a report earlier this week suggesting a slower pace of hikes were coming. Lagarde said the ECB will continue hiking and leave rates in restrictive territory as long as it takes to bring inflation down.

Euribor futures have ECB cuts priced in for late 2023 or the first quarter of 2024.

German-US 2-year yield spreads tightened further to decrease the dollar’s yield advantage over the euro as investors may be giving the ECB more credence than the Fed.

Technicals highlight upside risks, with a monthly bull hammer in place and the monthly RSI rising. The 10-day moving average also gives support, and EUR/USD seems likely to test the 50% retracement of 1.2349-0.9528 and the April monthly high.

(Christopher Romano is a Reuters market analyst. The views expressed are his own.)

 

SINGAPORE, Jan 18 (Reuters) – Japan’s yen, long favored as a safe-haven and funding currency, has in recent weeks become so enmeshed in market speculation over central bank policy that Wednesday’s decision to retain the status quo set off the steepest yen fall in nearly three years.

The yen dropped more than 2% after the Bank of Japan said it was sticking to its controversial yield control policy, in defiance of market expectations of a tweak to its yield cap or other settings. Those expectations had driven a 14% rally in the yen in the past three months.

In the bond market, where the central bank has battled bond bears to defend its yield cap, the BOJ has bought up so many of Japan’s outstanding 10-year government bonds that market liquidity has virtually dried up.

Speculators have looked instead to the yen, an easier target where their bets on BOJ policy have induced massive swings and historic levels of volatility.

Moh Siong Sim, currency strategist at Bank of Singapore, said it was a question of when, not if, the BOJ shifts its ultra-dovish stance, and the market would continue to test that by pushing the yen higher.

“For our clients, they think of the yen as a funding currency. That may have to shift,” Sim said.

Until late last year, the BOJ’s dovishness in the face of aggressive rate rises by the Federal Reserve and other major central banks meant the yen was cheap and weak, making it the perfect currency to borrow for investments.

But it’s not so easy now, Sim said.

“A one-sided story is starting to flip around, and now it involves a bit more of a balancing act, between the low borrowing cost and currency moves.”

As the yen rallied more than 15% from October’s 32-year low of 151.94 per dollar to last week’s peak near 127, volatility spiked. The overnight volatility priced into yen options is around a six-year high of 54%.

BIGGER YEN BETS

Analysts expect bets on the BOJ soon abandoning its yield curve control policy will get bigger and louder, for several reasons.

Some investors expect the central bank to use evidence of rising inflation and a change of the guard at the BOJ in April as an excuse to make a move. Domestic investors say the pressures of managing a highly distorted yield curve and increasing bond market dysfunction are sufficient reason for the BOJ to act.

Most of that speculation has to be channeled into the yen.

Tareck Horchani, head of dealing, prime brokerage, at Maybank Securities, said macro funds have been buying derivative structures and put options on the dollar-yen pair, betting on the yen heading to 115 or 110.

Even equity fund managers investing in Japan have stopped hedging their currency exposure in the hope of cashing in on yen appreciation, he said.

James Athey, an investment director at fund manager abrdn, has held a long position on the yen for a while.

“We were quite well-positioned for the move in December from the BOJ. We had a significant overweight on the Japanese yen, (and) in the aftermath, we took profit on some of our yen position,” Athey said.

Rises in bond yields and the yen could create a vicious tailwind of fund repatriation flows into Japan, yet some investors expect the yen’s path higher won’t follow a straight line.

Among those watching from the sidelines are hedge funds that took a hit on their short-yen trades, which were hugely profitable for about 10 months of 2022 until a swift reversal in the yen in the last few months.

“Macro hedge funds that lost money in the final months of 2022 on their long-dollar positions are just mildly positioned for a yen rally and are worried about a sharp reversal,” said Maybank’s Horchani.

Such uncertainty is also a challenge for the allocations of stock investors, who benefited from a cheaper yen last year as exports became more competitive and many Japanese companies got an earnings boost, lifting the Nikkei.

“The debate around the future of BOJ policy is far from settled,” said Howard Smith, partner, and portfolio manager at Indus Japan Strategies.

Smith still sees value in Japanese assets and companies as the yen heads for 120 per dollar, or even 110, but for now he is only partially unhedged in his fund’s long-short products.

(Reporting by Ankur Banerjee, Rae Wee and Tom Westbrook in Singapore, Summer Zhen in Hong Kong and Nell Mackenzie in London; Editing by Vidya Ranganathan and Edmund Klamann)

 

SINGAPORE/LONDON, Jan 19 (Reuters) – The dollar slipped on Thursday after a raft of data showed the US economy is losing momentum, while the yen rebounded as traders continued to bet the Bank of Japan will shift away from ultra-loose monetary policy.

US data released on Wednesday showed retail sales fell by the most in a year in December and manufacturing output suffered its biggest drop in nearly two years, stoking fears that the world’s largest economy is headed for a recession.

The figures prompted a sharp drop in US government bond yields as investors bet the Federal Reserve would be unable to raise rates as high as previously expected and sought out safe assets.

Analysts said the fall in yields, which makes dollar-denominated bonds less attractive, was one factor weighing on the greenback, along with a rebound in Japan’s yen.

The euro was last up 0.23% against the dollar at USD 1.082. It hit a nine-month high of USD 1.089 on Wednesday before paring its gains.

“The developments make us more confident that the Fed is getting close to the end of their tightening cycle, and support our bearish US dollar outlook,” said Lee Hardman, senior currency analyst at Japanese bank MUFG.

Yet Hardman said the dollar should not fall too far, given it’s seen as a safe asset in times of economic stress.

Meanwhile, the dollar fell against the Japanese yen and was last 0.57% lower at 128.17 yen. That almost unwound the previous day’s rally, which came after the BOJ’s decision to stand pat on its ultra-loose monetary policy.

Defying market expectations, the BOJ kept its interest rate targets and policy of yield curve control intact, and instead crafted a new weapon to prevent long-term rates from rising too much in a show of resolve.

The decision sent the yen plunging some 2% against the greenback, although the currency later rebounded to finish roughly 0.6% lower.

“It’s really reflecting the fact that market participants are still speculating (on) a shift in the Bank of Japan’s policy despite their inaction yesterday,” Carol Kong, a currency strategist at Commonwealth Bank of Australia, said of the yen’s rebound.

“While there’s still high expectations for a policy shift … I think that will keep the yen pretty elevated in the near term.”

Sterling slipped less than 0.1% to USD 1.234, after falling from the previous session’s one-month high of USD 1.244.

The US dollar index, which measures the greenback against a basket of peers, fell 0.14% to 102.19.

The Aussie slumped 0.71% to USD 0.689, further pressured by a surprise dip in Australia employment in December.

Meanwhile, the kiwi lost 0.84% to stand at USD 0.639.

New Zealand Prime Minister Jacinda Ardern on Thursday made a shock announcement that she would step down no later than early February and not seek re-election.

Investors will be keeping an eye on the World Economic Forum in Davos, Switzerland, where European Central Bank chief Christine Lagarde is due to speak on Thursday.

US economic data will also be closely watched, with weekly jobless claims and housing figures due later in the day.

(Reporting by Rae Wee and Harry Robertson; Editing by Gerry Doyle and Kim Coghill)