Global FX: Interrogating the optimistic baseline

(upbeat music) - Hello and welcome to this at any rate FX podcast. I'm your host, Arindam Sandhilia. And I have three familiar faces with me on the call today. Juliet and I say James Nelligan and Patrick Locke or senior strategists on the global FX strategy team at JP Morgan. This was a holiday, short and weak in markets. So the overarching theme really was consolidation. Trude betalled not a ton happened. Mind you, we are recording this before any potential Supreme Court decision on IEPA. So that statement may not hold in an hour's time. But on the whole, the weekend throughout very many new threads, otherwise for us to tag on as far as existing views are concerned. The sharp sell-off in US text talks and crypto of the last few weeks seemed to obeyed a little bit this week. But the questions about potential spillovers on two pro cyclical FX are never far from the surface in our conversations. And I'd like to say I'm pleasantly surprised at how well our highest conviction, high beta G10 FX calls specifically Aussie and Norway have held up in the midst of this equity volatility and also the chaotic price swings in industrial commodities, especially in the case of Aussie, and Norway actually like the move higher in oil. Which only goes to show that these, an emotionally commodity exporting currencies are far more than just simple terms of trade stories. Domestic cyclical strand has reflected in, say, in last week's strong CPI print in Norway or this week's strong Australian job status is a key component of the story that informs a hawkish bias on the respective central banks. You know, there's also some positive flow asymmetries to boot in the form of Norway's bank FX purchases or Aussie superannuation funds, FX hedging and so on. But on the whole, the dollar did back up towards 98 on the TXY that came after hawkish leading Fed Minutes that's probably caused some pain for new limited yen bulls that wasn't entirely on the bingo card for us. And it probably deserves some unpacking this week. Then in my neck of the words, people are concerned about whether the end of the Lunar New Year holidays next week will bring with it a different set of currency trends in APEC, especially in CNY as it often ends up being the case. Then on a seasonal basis, when corporate dollar conversion to either pay bonuses or settle vendor payables, the holidays is done, dollar CNY and prolly dollar ratio tends to inflect higher. And then there is a perennial question of the weekend threat of Iranian geopolitics, which seems to have taken on a new urgency of late. So rather than vlog a very dead horse in terms of our model views on dollar bearishness and pro-risk bullishness that regular listeners should be more than aware of at this point. And I thought that we'll spend the next few minutes interrogating our optimistic baseline along some of these risk dimensions. So maybe James, I'll start with you, the issue of equity sectoral churn in the US, volatility, VIX creeping high above 20, spillovers onto cyclical FX. So this is one of the FAQs that crops up in our conversations and inclined meetings. So Q1 to you is, how much does this worry you and what should be be wanting here? - Yeah, so I think this in terms of the equity rotation that you mentioned, there's a few different angles to it in terms of, part of it is better global growth, part of it is relative valuations and what the market may or may not think about those in relation to kind of US tech, part of it is AI disruption that we've seen over the last few weeks in different sectors. And all this is happening while kind of, you know, US equities are sitting on kind of range lows, but US and global data surprises are at the highs. So one thing we feel kind of comfortable saying is, this isn't a growth driven US equity weakness, which is what would worry us a bit more in terms of our cyclical positioning. You know, if you look at relative equity performance in relation to relative earnings growth, they are actually tracking each other. So this isn't a dislocated move in relative equity performance. It's tracking relative earnings growth, which again gives us a bit more confidence in terms of the the cyclical thinking. You are also seeing risk parity strategies working. So yields are offering a little bit of a cushion to equities and that keeps kind of one channel, it's a little bit of a narrow channel, but for dollar weakness open. So it's not as much kind of the stagnationary backdrop that we saw a few years ago. And the thing that's probably most important to me is some of the equity internals outside the US are suggesting that we're going to get some pretty strong PMI numbers, which is obviously what cyclical assets have begun to price. We have actually seen that data in some places. So if you look at like New Zealand PMI, UK, ISM and the US, we haven't yet seen it in Europe. European equity internals are very, very, very positive. And you know, we saw obviously a beat on the PMI today in Europe, but in my view, it's still kind of falling a little bit short of what equity internals are suggesting. So I've got a bit of patience there, but I'd say let's wait for the next one or two prints and see how we do. European data surprises still at the highs. And I think part of what's held cyclical effects back this week is partly the geopolitical risk, which Patrick will talk about. But also I think something a bit more nuanced in terms of what AI disruption is saying for rate spreads. And if you're going to bring inflation expectations lower at the two year point driven by potential AI disruption to the labor market, that's actually supported real rates at the front end of the US curve, even as nominal rates have come lower. And that's made it a little bit difficult, a little bit more difficult to see dollar weakness, even as the equity relative equity performance has moved further in favor of dollar weakness. That's why I think you've had that little dislocation this week where between, you know, because rates have actually been a little bit more of an important drive in the equities. So what do we need to see? I think we need to see rest of world growth data do a little bit more of the heavy lifting, which are indicated in our leads and our models are telling us is going to come through. We've seen a little bit of a stall in our growth revisions, but we're willing to be patient on this data and see how we go. And I think the PMI's overall today so far have been a bit of an encouraging sign. - Okay, very good. Let's just hope that this subsurface sectoral rotation remains exactly that and doesn't spill over into broader indices. I guess one of the points that you've made in one of your notes is just keep working credit spreads for whether this takes on an uglier term. If it does, then obviously we'd have to revisit our thesis on cyclical assets and cyclical effects. But we talked about disconnects. And so Junia, next question to you, a very noticeable disconnect in Japanese fixed income versus FX markets, long-in JGBs, where yields have stensibly deprised some fiscal risk premium noticeably cooled down over the past two to three weeks, versus the lack of fall or three lower end dollar A. And I think that's caused a lot of frustration amongst short term investors, it's caused a lot of headscratching judging from the number of questions that have come through. Why is Yen FX seemingly unwilling to price out fiscal risk when Yen rates look much more agreeable to the idea? - I'm Planky very much, and I'll follow the question. As a best one and the starting point for the discussion, later on the discussions, I would insist that the relationship between Yen's interest rate and Yen's effects rate is not historically stable and the relationship between two is conditional and could be changing quickly. So this is the starting point. And listen to the grind in the long wind and the super long wind JGB is mainly due to the easing fiscal concern after the LDPs run to slide victory in the lower house election. With the LDP holding a strong majority, the market has strengthened the view that there is a best need to accommodate the every opposition demand, totally different from the last November's Supreme Budget case. And that consumption tax cut will likely be and one of major as was promissed by LDP. On the fiscal policy, the current market focus is funding sources for consumption tax cut and the size and the financing measures of the expected Supreme Budget accompanying the growth strategy. Both are expected to be decided around June. So just think it may take some time before fiscal concern will resume. This fiscal year's initial budget is reportedly targeted for passage until April, but we do not expect any major surprises on this. Given that over the next few weeks, fiscal policy is unlikely to be the major market driver and the risk premium should remain subdued. Historically, the correlation between long wind and super long wind JGB and the yen has not been consistent in negative. And the negative correlation observed after the long job of the TAKARTI adonatovation arose in the idiosyncratic context in which fiscal premium became the main driver of both yen rates and yen exchange rate. Therefore, if fiscal premium received, the relationship between yen rates and yen exchange rate can be brought to its usual positive correlation. The recent softening of yen, despite the lower JGB, might suggest the start of such kind of shift. Since the LDP leadership election last October, the LDP has shown a negative correlation with US Japan one year forwarded one year rate different shows. This relationship has mainly been driven by a negative correlation between yen and the yen's one year one year rate. We believe the main driver of negative correlation between two front yen rates and the yen exchange rate is a concern that the B.O.J.S and the policy will fall behind the curve and the TAKARTI adonatovation. Therefore, if those concerns received, the positive correlation between front yen and the yen rates and the yen could be due. Indeed, in the first quarter of last year, a rising expectation for more hope is to be O.J. partly due to the pressure from the US government pushed front yen and the yen rates higher. And this was accompanied by yen appreciation. So all this means that the correlation between two was positive, not negative. Since the election, Prime Minister Zagaiji has not suggested pressureing B.O.J. to keep policy rate as low as possible, which may have eased market concerns that B.O.J. will fall behind the curve to some extent. If that concern have diminished it, have been diminished. It would be reasonable for the negative correlation between front and yen rates and the yen to weaken. And for a positive correlation to resume. Separately, the recent pullback in the federal rate cut expectation is also supporting for the yen with regard to the correlation between one year one year, let's expect that the yen. The easing of concern on fiscal and B.O.J. policy is a key for normalization in rates effects relationship. As I said, as fiscal concern are likely to remain contained at least in the near term, market attention is now shifting towards B.O.J.'s monetary policy. The immediate focus is new B.O.J. policy board appointment scheduled for February 25. We continue to think B.O.J. policy will become behind the curve under the Takaichi Adominion Association. And appointment of Davish board member could resume such concern. That's for me. OK, so maybe a temporary abatement of fiscal concerns, temporary being the operative word, maybe some technical reasons related to these proposed rules around unresolved losses on life as bond portfolio, et cetera. I may have something to do with this wedge, but something tells me that we have not seen the last twist or turn in this fiscal and B.O.J. behind the curve saga. So ice peeled on that in the coming weeks. But Pat, now moving over to you. I guess a couple of questions in the spirit of stress testing. This dollar move up over the past week and the hawkishness in fact minutes, would you make of all of that? And do you say any next to our US trade skies and speaking to our US economists all the time? So what's the view coming from there? And then again, in the spirit of asking difficult questions, thoughts about Iran, the geopolitical threat, what might it do to the overall risk complex? Yeah, thanks, Arunam. So maybe starting with kind of like the e-con development. So I mean, certainly I think the minutes this week were very interesting. I've said for a while of it, minutes have kind of become less and less interesting over the years, just given the kind of the array and the breadth of kind of like Fed speakers that we have immediately after our form sea meetings, the kind of color in between the lines. But I think certainly there was much more willingness to consider going in the other direction here from some Fed committee members. And you take that against kind of the revisions and inflation and the unemployment rate that they had. And it's starting to align much more with kind of how our economists have been talking about how to think about the US through the rest of the year, which is pretty firm growth, pretty sticky inflation. In particular, right now we're seeing kind of like core PCE-related CPI lower unemployment rate, less slack. And maybe if the Fed kind of continues to revise up its estimate of neutral, then mechanically in the Taylor rule, that suggests policy rates should be a little bit higher, not lower. So that I think in part motivates our call for no cuts. And it looks like the Fed, the committee members are starting to think a little bit more along the lines in that direction. Obviously this comes on the back of a pretty solid NFP for the last week. So the real question is like, why hasn't the short end been done more? You can't obviously link kind of a dollar's rebound this week to kind of a significant rethink of either terminal, which still has more than a couple cuts priced in. Or kind of like a just a broader complex move in the rates. And we continue to see like a decent discount kind of around mid-year, potentially linked to chair or worse starting in terms. But nevertheless, I think the lack of short end move given recent developments is rather striking in something certainly to kind of keep an eye on. So that's one. And then, yeah, as I would say about kind of like the US around situation, I guess I would make a couple points. First is that it's pretty interesting. I think that the macro backdrop is actually reasonably comparable to what happened when the US attacked Iran last summer, which was basically a pretty positive growth environment, kind of like the reopening or kind of like deprising of tariff beers after liberation day. Dollar positioning was shorter than it is now, but both are pretty decent sized dollar shorts. So definitely some kind of like kind of comparability there, I think. And then you look at kind of the relative price action, most notably after last year, oil sold off after the attack, equities kept rallying. And basically the dollar sold off fairly meaningfully on a broad basis after basically rallying kind of like into the event along with the oil risk premium, if you would. So that altogether suggests that perhaps there is a path, in this case, where even if there is an attack on Iran, then perhaps it's not necessarily going to be kind of like a major deliveraging, be risking kind of episode where dollar shorts get on wound and kind of the prosycical trade and the rotation that everyone has been very interested in lately. It's kind of runs into a wall. It's not based on recent history. It's not necessarily guaranteed. But obviously you need to tread lightly with these things. I think at the end of the day, X-Post, the intervention last June was probably relatively surgical, wicking it out in last very long. We don't know kind of the objectives or the goals if they were to attack this time, how long it might last. And obviously that all eventually get factored into how markets ultimately respond and how risk premium trades or gets deprised. So certainly not kind of like projecting anything with absolute confidence here. But I'd say for those interested in like maintaining kind of the pro-risk bias. I think last year's episode at least is a good indicator that some of these exogenous, durable local shocks don't necessarily have to result in kind of a major deal ever, James. I hope you're right on that one. But if for people who are interested in kind of hedging this tactical thread, my only observation is if you look at Patrick's Positioning Monitor, which is an excellent publication, by the way, you will see that off all the haven effects. I'm just struck by how short positioning continues to screen on the Swiss franc. It's one where we are modally calling for weakness as well. But obviously on any sort of geopolitical risk off, I think those shorts are vulnerable to being mainsed in a volatile fashion. All right, at my end, let me just finish up with some quick thoughts on C&Y and the end of the bullish Lunar New Year seasonal wind run. What it may or may not mean for our in-be going forward. Look, if this was any other year, I'd have said every chance that three, four months long, bullish C&Y trend almost in a straight line will take a breather. I think the reason why this year could be different is that US and China are locked in trade negotiations, as we know, in the lead up to President Trump's state visit to Beijing in early April. We generally know that FX policy has been a renewed focus of late as far as North Asian trade partners go, and albeit the multi-pronged policy levers that create authorities of bold since late December to stem the tide of one weakness, be it the joint late check on Dolly N in late January. Or the explicit calling out of the need for C&Y appreciation in the latest US Treasury report to that bad-uget flag in this podcast last week. So it is not inconceivable and fully acknowledged that we are guessing from the outside here that some sort of C&Y appreciation in exchange for Tadifra Leaf could be a potential quid pro quo that's on the table. One that would make the Chinese side reluctant to upset the Apple card on C&Y for the Trump visit. So which is why my guess is even if the fixings fall more slowly than before from here in the pace of C&Y appreciation flags a little, that trend probably won't reverse wholesale. But the proof of the pudding will be in the fixings and the C&Y spot price action by channel returns from holidays next week. All eyes will be on the 9.15 AM fixed release on Monday. So lots to play for, not just for C&Y, but also correlated plays like Aussie. OK, so let's leave it there for this week. Thanks to all our listeners for tuning in. This communication is provided for information purposes only. Please refer to JP Morgan research reports related to its content for more information, including important disclosures. 2026 JP Morgan Chase and Company, all rights reserved. This episode was recorded on February 20th, 2026.