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Yen Bulls Eye Europe Amid ECB Cuts, BOJ Rate Hike Risks

EUR/JPY faces downward pressure amid French elections and ECB uncertainty, with implied volatility rising.

By Athena Xu

6/10, 20:36 EDT

Key Takeaway

  • EUR/JPY faces downward pressure due to early French elections and potential ECB rate cuts, increasing political risk in Europe.
  • Asian FX markets brace for volatility amid US Treasury selloff and upcoming economic data, with BOJ hinting at a July rate hike.
  • Rising European political risk may limit ECB's ability to ease monetary policy, despite market expectations of Fed out-cutting the ECB.

EUR/JPY Path Lower

The EUR/JPY currency pair is expected to face downward pressure in the near term, influenced by political and economic factors. The recent announcement of early French elections has introduced significant political risk, which is likely to weigh on the euro. Traders' reactions to President Macron's decision were evident in the options market, where volumes surged for most euro crosses on Monday. Notably, EUR/JPY appeared at number five on the global list, accompanied by a rise in implied volatility. This suggests that investors anticipate continued pressure on the euro throughout the dual French voting sessions, which are expected to extend into early July.

Additionally, the fallout from the European Union elections may impact the European Central Bank's (ECB) decision-making process for their upcoming meeting on July 18. Traders are likely to interpret the political uncertainty as increasing the odds of another interest rate cut, which could further undermine the euro. The heightened political risk in Europe, combined with the upcoming central bank meetings, creates a challenging environment for the euro against the yen.

Asian FX Volatility

Asian foreign exchange (FX) markets are expected to experience increased volatility this week due to a selloff in US Treasuries and upcoming economic data releases. The market is currently leaning towards a potential US interest rate cut in December, and the Federal Open Market Committee (FOMC) meeting will provide insights into how recent data has influenced official thinking. The release of US Consumer Price Index (CPI) data is also anticipated to contribute to market volatility.

In Japan, the yen remains vulnerable as the Bank of Japan (BOJ) may discuss scaling back bond-buying operations and hint at a potential rate hike in July. While these moves could support the yen, its trajectory will ultimately depend on the FOMC's decisions. In India, the reappointment of Prime Minister Narendra Modi is expected to stabilize the nation's assets. Foreign investors will be looking for continued commitment to economic reforms and a pro-growth agenda from the new administration. Despite political uncertainties, bond market flows and currency stability remain positive factors for India.

European Political Risk

Rising political risk in Europe has validated the expectations of interest-rate swap traders, who anticipate that the Federal Reserve will out-cut the European Central Bank (ECB) and other peers in the first half of next year. The recent election results in France and Germany, along with the surprise announcement of a French parliamentary vote, have introduced significant uncertainty. The ECB's June rate hike, which was previously locked in with explicit forward guidance, now appears premature. Some analysts, such as Simon White, argue that the rate hike may even need to be reversed.

This situation creates a scenario where the euro remains weak, but the ECB is unable to ease monetary policy as much as the Federal Reserve. As a result, relatively higher swap rates may not be reflected in the currency. The selloff in both bonds and the euro suggests that the market is adjusting to the new political landscape in Europe. The potential for early elections in other European countries, such as Ireland, adds to the overall uncertainty.