FX Risk Index: Weaker; USD/JPY faces more downside risks
At -0.87 (vs -1.06 on 26 January 2017) our Risk Index has moved into less risk seeking territory. The latest development was mainly reflected in rising equity volatility. With uncertainty regarding US President Trump’s economic agenda intact, the main focus remains on protectionist developments for now and it cannot be excluded that cross market volatility will continue to rise.
It remains useful to look at US 5Y forward breakeven rates in order to evaluate if growth expectations are strong enough to strengthening the inflation outlook further in the wake of tighter conditions, as driven by the Fed. Regardless of the latest correction lower in the USD, 5Y forward breakeven rates have been capped.
Unless incoming data surprises positively and/or there are more details provided regarding fiscal spending plans, investors’ appetite for risk assets may have more room to fall, at least in the short-term.
As a result of the above outlined conditions we believe caution remains warranted when it comes to pairs such as USD/JPY. The pair does not only maintain a close correlation to risk but it is still subject to heightened position squaring downside risks too. This is well reflected, with speculative long positioning remaining elevated, as confirmed by our FX positioning gauge.