The third quarter is winding down and that beckons a look at what has unfolded so far in the forex market in 2023. At the top of the FX-trading charts is long GBP/JPY. It's a classic carry trade and it worked as well as ever this year as a global tightening cycle got underway.
Adding fuel to the fire was a series of overshoots in UK inflation. That supercharged this trade in June and has kept it near the highs.
What was less-predictable was the stubbornness of the Bank of Japan to holding rates unchanged even as inflation rose. The big risk to this trade all year long has been the possibilty of a BOJ change. Though there has been a tweak to YCC, rates (and real rates) are still deeply negative. That's made every dip a buying opportunity.
Zooming out, this trade is a reminder that there is nothing new under the sun and that during hiking cycles, it's rate differentials that drive the currency market. It's also worth pointing out that the Bank of England didn't hike this month and there is only about a 50/50 chance of a single further hike priced into the market (a far cry from when all the talk was about +6% rates).
Deutsche Bank argues that the final quarter of the year may feature a retracement, in part because Japanese inflation is proving to be stubborn.
Simply, at these levels it's hard to be anything but upbeat on yen - the real TWI is at a 50-year low. On our preferred DBeer framework it's 20% cheap - since 1996 only one other currency has got to this level (Figure 16). And it's not like JPY is persistently cheap on this metric (as it is with PPP for example) - it's been quite expensive at times in the past (eg, 2007-2012). The cheapness seems to have had a real impact - Japan's trade deficit from last year has been erased as goods exports outperform Asian peers (flat instead of down heavily year-on-year), while the tourism boom is helping on the services side.
The trigger for selling GBP/JPY is likely to be a period of falling stocks along with falling Treasury yields, something that's rarely happened this year.