Daily Market Comment – Yen, gold, and stock markets power higher

  • Yen goes on a rampage ahead of crucial BoJ decision this week

  • Gold hits new highs, driven by Fed speculation and softer dollar

  • Euphoria engulfs markets as stocks, crypto, and risk-linked FX gain

Yen soars ahead of BoJ

After sinking to the depths of Hades last year, the Japanese yen has staged a spectacular comeback. It is currently tied with the Australian dollar as the best-performing major currency this year, capitalizing on a perfect storm of narrowing interest rate differentials, global recession concerns, and cooling energy prices.

With the Bank of Japan raising the ceiling on long-term yields just as the Fed approaches the end of its own tightening cycle, monetary policy convergence has emerged as the new market theme, giving traders the green light to short Japanese bonds and buy the yen. Speculation is running rampant that the BoJ will take the next step in its normalization campaign when it announces its latest decision on Wednesday.

The ceiling on Japanese yields was violated several times lately as investors bet that yields will keep on rising, forcing heavy interventions by the BoJ to defend its target. Meanwhile, markets assign a 35% probability for an immediate 10 basis points rate increase this week, which would mark an exit from negative rates.

Admittedly, it’s a close call. While forward-looking measures for Tokyo suggest inflation continues to fire up, wage growth and consumer spending have disappointed, raising doubts about the durability of domestic inflationary pressures. Hence, a risk management approach would suggest there’s no rush for the BoJ to act again so soon. 

A decision to do nothing this week might come as a disappointment for the yen, although the broader outlook for the currency remains quite bright, as it is probably only a matter of time until the BoJ takes the next step.

Gold flies in early January

Gold is another asset that’s gone on a rampage this year, gaining nearly 3% last week alone to settle at its highest levels since April around the $1,920 mark. The driving forces behind this rally have been the sharp declines in yields and the dollar, amid expectations that the Fed is about to roll out its final rate increases for this cycle.

Central bank purchases played a big role too, as China and Turkey seemingly went on a buying spree late last year, boosting their gold reserves. For China, these purchases might reflect some diversification away from FX reserves and towards precious metals, to ensure that it won’t meet the same fate as Russia and have its warchest frozen in case its rivalry with the West intensifies further. 

Overall, the outlook for bullion remains favorable in an environment characterized by global recession risks and central banks hitting the pause button, although the chart currently seems overextended, raising the chances of a pullback. The main downside risk might be a resolution to the conflict in Ukraine that diminishes safe-haven flows, although that doesn’t seem imminent, while Kyiv continues to receive financial aid and advanced weapons.

Euphoria returns as crypto and stocks soar

A sense of euphoria reminiscent of the mood in 2021 has engulfed global markets, with crypto assets, meme stocks, and currencies linked to global risk appetite starting the year with a bang. A more cautious Fed profile now that inflation is losing its kick, China’s economic reopening, and a winter ‘heat wave’ in Europe that has diminished fears around the energy crisis have come together to engineer a strong comeback in riskier assets.

The market euphoria stands in stark contrast to the gloomy picture painted by most leading indicators and the earnings reports by major US banks last week, which warned that economic momentum is fading. Valuations remain expensive by any measure and the S&P 500 is currently at an important technical crossroads, challenging the year-long trendline that connects local highs.

US markets will remain closed today, celebrating Martin Luther King Day.

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