Despite strong UK retail sales and PMI data, the British Pound has weakened. This indicates that the market's focus has completely shifted away from cyclical data and towards the upcoming government budget. Concerns about potential tax hikes are adding a risk premium to the currency, overriding positive economic news.
Even if US inflation remains stubbornly high, the US dollar's potential to appreciate is capped by the Federal Reserve's asymmetric reaction function. The Fed is operating under a risk management framework where it is more inclined to ease on economic weakness than to react hawkishly to firm inflation, limiting terminal rate repricing.
Market participants misinterpret PM Takaichi's interventionist stance as a barrier to a Bank of Japan (BOJ) rate hike. However, her top economic priority is fighting inflation. Delaying a hike would accelerate yen depreciation and worsen inflation, making it unlikely she will strongly intervene to prevent a BOJ policy tightening.
The upcoming Bank of Japan meeting is the most critical central bank event, with implications beyond FX markets. A hawkish surprise could create a volatility event in Japan's long-end yield curve, which could easily reverberate across global rates markets, impacting carry trades and broader market stability.
Despite gold's significant volatility, G10 FX markets remained stable. This is because the historically strong relationship between FX and the gold-oil ratio has broken down this year. FX markets did not react to gold's earlier run-up, so they similarly ignored its recent sharp decline.
The upcoming US-China summit is expected to produce optics over substance. More importantly for traders, the FX market lacks a clear playbook for any outcome. The People's Bank of China (PBOC) has firmly anchored the Yuan, removing any 'trade war risk premium' from the currency and rendering the event largely untradable for FX.