DB FX Daily: EUR/JPY Supported by Spreads, Review of FX in Q1

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FX Daily: EUR/JPY Supported by Spreads, Review of FX in Q1

EUR/JPY Recovery Supported By Rate Spreads

The March ISM manufacturing index pointed to US manufacturing activity being close to flat while input prices continued to advance. As we have argued before, this mix of more stagnant growth and lingering price pressures is in our view a more negative USD mix as it is likely to be accompanied by US yield curve steepening and further compression of real rate spreads. But the immediate reaction in fixed income markets to this number has been contained as 2Y US yields have pushed slightly higher and the curve has flattened. Perhaps the steady diet of negative US data surprises has shifted the consensus towards expecting more negative data outcomes and the slowly growing short USD position are providing some short-term resistance to further weakness ahead of payrolls on Friday. In EUR however, 2Y yields continue to move higher pushing up 10 bps over the past two weeks. Though much of the focus has been on EUR spread widening against the USD of late, it has also been developing against JPY where yields have changed little amid mixed data. The chart at left below tracks 2Y EUR - JGB spreads which have widened back to levels last seen late January and have provided some more fundamental support to the rebound in EUR/JPY. The current environment with the market expecting further tightening from the ECB, little action from the BoJ and witnessing a recovery in risk appetite is likely to keep the rate support and the bid for EUR/JPY for the time being though we would expect several of these bullish factors to fade in the months ahead and the G7/IMF meeting could provide event risk as well.