The recent rise of global long-term bond yields remains the overriding driver of FX markets. Indeed, the move constitutes a tightening in global financial conditions that erodes market risk sentiment, and hurts higher-yielding and commodity currencies. Because the move has been fuelled by concerns about the BoJ's and ECB's ability to ease aggressively further, the unwinding of carry trades supports JPY and EUR. The prospects for rate normalization in the US before year-end further leads to tighter funding conditions and helps USD against smaller, less liquid G10 currencies.
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Next week could prove pivotal for the markets for two reasons. First, we expect the BoJ to announce policies to re-steepen the JGB curve and even cut depo rates further. Importantly, the meeting may not allay fears that the BoJ is quickly running out of options to ease further. All that could continue to push Japanese long-term yields higher. Second, the Fed should keep rates unchanged but could come out with a relatively more hawkish statement, potentially making reference to a rate hike in the coming months.
The BoJ and the Fed meetings could add vigour to the latest tightening in global financial conditions, and lead to further underperformance of commodity and high-yielding G10 currencies. Growing uncertainty ahead of the US presidential election could also fuel the headwinds for market risk sentiment as we approach the first televised debate on 26 September.
USD/JPY could remain caught between re-emerging policy divergence on the one hand and escalating risk aversion on the other. That said, we think that short-term volatility should remain bid ahead of next Wednesday.
NZD and NOK look particularly vulnerable ahead of the RBNZ and Norges Bank meetings next week given that the markets remain rather complacent on the prospects of further easing this year. The outlook for commodities should remain challenging as markets are starting to position for more gradual rebalancing of the oil market. NZD, AUD, CAD and NOK are also among the most expensive currencies in G10 according to our new valuation model. EUR should benefit from further safe haven inflows and outperform currencies like CAD, which could suffer on the back of disappointing inflation and retail sales data.