Market Focus Shifts to Fed; Upside Confidence on EUR/GBP Trade

Overview

This report indicates that with the U.S.-Iran memorandum of understanding signed and a temporary ceasefire agreement reached, the geopolitical risk premium associated with the Middle East is diminishing, shifting market attention back towards the Federal Reserve’s policy response logic. Nomura observes that although regional tensions have eased, under new Chair Warsh, the Fed has shown a more cautious approach to inflation, leading to earlier-than-expected market expectations of interest rate hikes. Based on this analysis, the firm adjusts its tactical allocations across G10 and Asian foreign exchange and interest rate markets, emphasizing opportunities arising from yield curve convergence and divergent macro fundamentals, while also warning about potential Japanese government forex interventions.

Core views

In terms of G10 FX, the report notably increases confidence for going long on the euro against the British pound (EUR/GBP) to a level of 4 out of 5 (the maximum). The rationale behind this adjustment lies in the relatively dovish tone of the Bank of England's recent meetings alongside unexpectedly downward revised UK inflation data, while European Central Bank officials continue to signal possible further rate increases, anticipating a terminal rate differential of 75 basis points which would drive EUR/GBP toward 0.90. Conversely, given the sharp rise in risks related to interventions by Japan's Ministry of Finance (with USD/JPY exceeding 160.70 and nearing a pivotal threshold at 162), the report closes out prior recommendations for being long on the Swiss franc versus the yen (CHF/JPY) and cautions that the likelihood of such interventions below 163 remains high. Regarding North American currency pairs, the report maintains its advice to go long on the U.S. dollar versus the Canadian dollar (USD/CAD), with a target of 1.425. While the ceasefire between Iran and the U.S. leads to a significant drop in oil prices, undermining the commodity-backed strength of the Canadian dollar, the hawkish stance of the Federal Reserve coupled with an expectation of inaction from the Bank of Canada widens the two-year yield spread between the two nations, bolstering the U.S. dollar. For the Australian dollar (AUD), the report adopts a cautiously neutral posture, noting that although the Reserve Bank of Australia retains options for additional rate hikes, it has been overshadowed by the Fed's more aggressive 'hawkish' direction, and that falling oil prices pose challenges for Australia as an energy-exporting nation. The Asian FX and interest rate strategy exhibit a structural divergence. In China, despite pressures stemming from the Fed's hawkish orientation in the short term, the report keeps its confidence level for going short on the U.S. dollar versus offshore Chinese yuan (USD/CNH) unchanged at 3 out of 5, aiming for a target of 6.60. This is justified by factors such as declining daily midpoint rates, strong corporate renminbi settlement activities, and the People's Bank of China introducing new liquidity tools (FIMA RMB Repo). Concerning the Singaporean and Indonesian pairing, maintaining a long position on the Singapore dollar versus the Indonesian rupiah (SGD/IDR), targeting 14,600, primarily addresses concerns over Indonesia's adequacy of foreign exchange reserves, MSCI rating review risks, and doubts surrounding fiscal sustainability. As for Taiwan, continuing to advocate for going short on the U.S. dollar versus New Taiwanese dollars (USD/TWD) benefits from robust fundamental drivers driven by global demand for AI technologies and inflows of foreign investment. On interest rates, the suggestion involves paying short-term NDIRS in Taiwan, India, and China (betting on rising yields or steepening curves), whereas in South Korea, one should receive 2y_fwd_5y NDIRS (anticipating a decline in longer-term yields).

Analysis framework

The report employs a comprehensive analytical framework integrating 'macro-event-driven,' 'yield convergence,' and 'relative value-based fundamentals.' First, it assesses the immediate impact of geopolitical events (U.S.-Iran truce) on risk appetite and commodity prices to filter out short-term noise; then focuses on policy differences among major central banks (such as those between the ECB and BoE, or the Fed and BoC), applying theories of interest rate parity to forecast exchange rate trends; finally, it verifies the robustness of trading logic using country-specific macroeconomic data (like inflation, employment, trade surpluses) and policy instruments (including central bank interventions, liquidity facilities). This top-down screening of dominant macro themes followed by a bottom-up search for micro-trading opportunities with high-confidence alignments exemplifies a typical path taken in foreign exchange strategy research.

Methodology notes

• Macroeconomic framework

  Analysis of Central Bank Reaction Functions

  The report underscores the shift in market focus from geopolitical issues to how the Federal Reserve reacts to inflation data. It implies that investors need to anticipate central banks’ policy inclinations when faced with specific economic indicators (like core PCE) rather than merely focusing on current interest rate levels.

• Industry/Industrial Analysis FrameworkSupply-demand framework

  Terms of Trade Impact on Exchange Rates

  The report notes that a decline in oil prices negatively impacts currencies of commodity-exporting countries (like Australia, Canada) while positively affecting importers (New Zealand, Japan), illustrating a classic method analyzing the influence of export-import price ratios on exchange rate fundamentals.

• Fixed Income & Credit AnalysisYield curve analysis

  Yield Curve Shape Trading (Steepeners/Flatteners)

  In the context of Asian interest rate strategies, the report expresses views on changes in yield curve slope through transactions involving NDIRS of various maturities—for instance betting on downward movement in long-end yields in Korea or upward shifts in short-end yields in India.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• EUR/GBP

  Beneficiary Asset: Long Position in EUR/GBP

  Strengths

  Clear contrast between hawkish EC B stance and dovish Bo E policy creates substantial room for yield gap convergence

  Weaknesses

  Logic could falter if UK inflation proves stickier than expected or if Eurozone economic data deteriorates sharply

  Comparison

  Superior to other G10 cross-rates because policy divergence here is most pronounced

  Risks

  Weakening Eurozone inflation/activity or unexpected UK inflation prompting Bo E to act more hawkishly than projected by the market

• USD/JPY

  Adversely Affected Asset: Short Position in JPY (or closing previous long CHF/JPY positions)

  Strengths

  Significant underlying yield advantage supports USD

  Weaknesses

  Extremely high intervention risk by Japan's Ministry of Finance without any preceding warnings

  Comparison

  Unique among G10 currencies due to unprecedented policy-related intervention risks facing JPY

  Risks

  Intervention by Japanese authorities within the 162-163 range

• SGD/IDR

  Beneficiary Asset: Long Position in SGD/IDR

  Strengths

  Stronger macroeconomic outlook for Singapore with controlled inflation contrasts starkly with Indonesia's vulnerabilities including inadequate forex reserves, MSCI downgrade threats, and fiscal stability concerns

  Weaknesses

  Delayed rate hikes by Bank Indonesia might fail to match depreciative pressure on IDR

  Comparison

  Among Asian crosses, SGD stands out with the strongest fundamentals while IDR faces highest fragility

  Risks

  Export revenue regulations benefiting IDR or sudden improvements in global risk sentiment could undermine the position

Key data

• EUR/GBP Target Price0.8950Target set for end of August, confidence level at 4/5
• USD/CAD Target Price1.4250Target set for end of July, confidence level at 3/5
• USD/JPY Warning Threshold162.00-163.00Report suggests very high probability of intervention by Japanese authorities before these thresholds are reached
• USD/CNH Target Price6.60Target set for end of August, confidence level at 3/5
• SGD/IDR Target Price14,600Target set for end of August, confidence level at 3/5
• U.S. May Core PCE Prediction0.376% (MoM)Exceeds consensus expectation of 0.3%, supporting a hawkish interpretation

Impact & implications

The report posits that in the near term, market volatility may decrease due to reduced geopolitical tension but could increase again as the Federal Reserve’s policies introduce new sources of uncertainty. Investors might need to reassess purely geopolitically motivated hedges (like going long on the yen or gold) in favor of carry trades and relative value strategies derived from monetary policy differentials. Specifically, the trend of euro appreciation against the pound appears sustainable, while within Asia, stronger performance is anticipated for currencies like the Singapore dollar and renminbi compared to more vulnerable ones like the Indonesian rupiah affected by internal structural issues.

Risks

• Unannounced Forex intervention by Japan's Ministry of Finance once USD/JPY hits the 162-163 zone
• Lower-than-expected readings on core PCE data potentially softening the Fed's hawkish stance
• Escalation of tensions in the Middle East causing another spike in oil prices and reversing risk-on sentiment
• Downgrade of Indonesia by MSCI or S&P triggering capital flight
• Unexpectedly persistent inflation in the UK forcing the BoE into a more hawkish policy trajectory

What to watch

• U.S. May core PCE price index (projected MoM growth of 0.376%)
• Japanese Ministry of Finance’s verbal interventions or actual actions regarding exchange rates
• Eurozone PMI data and inflation expectations
• Results of Indonesia’s MSCI annual market classification review scheduled for June 23rd
• Singapore’s May industrial production growth and core inflation figures
• Speeches by BoC Governor Macklem and Senior Deputy Governor Rogers