Overall, it has been a relatively quiet week in the FX market, especially under the circumstances. Indeed, the lack of fresh news from the ongoing trade negotiations between the US and China has compelled investors to focus their attention on Brexit developments. Therefore, unlike most G10 currencies the pound sterling had very bumpy week as it was left at the mercy of the vagaries of UK lawmakers.

One could have easily anticipated that the lack of clear driver would have led to increase nervousness among market participants, which should have inevitably affected the option market. With the exception of the pound sterling that has not happened. Indeed, implied volatilities of option on G10 currencies – across maturities – have consistently moved downward, suggesting that investors do not know where to stand following the dovish shifts from both the Federal Reserve and ECB. As usual, investors were more inclined to buy protection against a bullish dollar move, especially against the pound. The divergence between short-term and medium-term in risk reversal measures suggests that market participants have ruled out the eventuality of a Brexit resolution within the next few weeks. The short-term 25-delta risk reversal measures (1-week and 1-month) have recovered lately as they inched up to -0.35 % and -1.14%, while longer-term ones (3-month and 6-month) have stabilised around -1.91% and -2.09%.

The publication of lacklustre economic data on both side of the Atlantic has left investors in catatonia. How to respond to a global slow down? Buy USD? Take shelter into safe haven assets such as the Japanese yen or Gold? Next week’s FOMC meeting could bring some light into the darkness. However, do not expect too much from the Fed, they are already struggling to shrink their balance sheet without triggering a financial crisis.

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Japan declines again

The Japanese economy continues to suffer from China’s economic slowdown and Sino-American trade tensions. So the Bank of Japan voted 7-2 to maintain its policy balance rate unchanged at -0.10% while maintaining its target for 10-year bond yields along zero and annual bond purchases at JPY 80 trillion ($716.32 billion). We do not see any improvement coming. The US-China Trump-Xi meeting initially planned for mid-March has been postponed for 2-4 weeks. Until then, news will be foggy, and Chinese stimulus policies will not kick in until Q3. Currently trading at 111.65, USD/JPY is heading along 111.45 short-term.

Economic headwinds forced the BoJ to revise exports and production downward. January exports dropped -9% (prior: -5.80%), their lowest in three years and the third consecutive drop while imports have rebounded 0.50% (prior: -2.20%) in the same period. There was an unexpected pick up in the January current account balance of JPY 600.4 billion (prior: JPY 452.8 billion) amid a sharp rise in investment income due to an expansion phase in financial markets, yet the drop in January machine orders by 5.40% suggests further slowdown in Q1. BoJ’s change of language from “increasing as a trend” to “recently showed some weakness” shows the situation is not expected to improve until Q3. Assumptions of 2% inflation have now become wishful thinking.

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