Opinions

On the rate front, we expect the BOJ to leave the policy rate unchanged at its 30–31 July Monetary Policy Meeting (MPM). It just recently hiked interest rates in June, and we expect it to adopt a wait-and-see stance at the July MPM while keeping a close eye on the impact of rate hikes to date. We might see two dissents for a rate hike from Board members Hajime Takata and Naoki Tamura. We expect the BOJ to lower its CPI inflation outlook and raise its GDP growth outlook in view of the situation in the Middle East. However, we do not expect the BOJ to change its assessment that the distribution of risks to prices is skewed to the upside. In governor's Ueda press conference, we will be looking for his comment's on BOJ's independence. We expect upward pressure on prices from summer & ongoing rate hikes. Even annual wage negotiations have produced large hikes, including for SMEs. BOJ has been slow in responding to consistently high inflation in Japan. In addition, the fiscal stimulus of current Takaichi administration adds fuel to the fire of higher bond yields and depreciating JPY. We now see JPY staying elevated in 162-165 range if there is no intervention by MoF. We see a terminal rate of 1.5% by H1CY27 against the current policy rate of 1%. We have been bearish on JPY for past few months and remain of the view that without rate hikes being frontloaded, JPY has no saviour.

The FOMC July meeting might see a vigorous family fight between the hawks and centrists. But in the end, Warsh might prevail for a hold yet the FOMC statement might be hawkish. To neutralise the FOMC statement’s hawkishness, Warsh’s press conference might leave enough dovish hints on June favorable CPI prints, low wage inflation & stable market indicators of long-term inflation expectations. From a market perspective, our 1yr-1yr US SOFR 1st half risk risk is received at 4.15 and another half risk waiting to get received at 4.25. This week’s high was 4.23 before it cooled down to close at 4.20. We have a profit target of 3.9 and stop loss at 4.4 for this trade. On the FX side, we continue to believe in DXY strength at least till Sep and continue to see JPY and GBP most weak against DXY. This has played out well till now as JPY is now nearing almost 164 levels & GBP is underperforming G-7 FX due to fiscal worries as well.

We believe the ECB will leave rates unchanged at its 23 July meeting, despite the reescalation of the US-Iran war since 7 July. We continue to believe that ECB will hike by 25 bps in Sep meeting and be done with the rate hike cycle. Markets currently price around 45bp of cumulative hikes in H2 2026; assuming a similar amount is priced going into the July meeting, we would expect marginally less to be priced by the end of the press conference. Recent ECB speak is supportive of a July hold in rates, even by the hawks. We believe that ECB market pricing at any time remains an oil trade. So, if oil continues to trade north of $85-90 levels on Brent in REMCY26, we can’t completely rule out Dec hike. But that is not our base case as of now. We believe Mme Lagarde will urge caution and underscore that uncertainty is elevated, indicating the impact on the Euro area economy depends entirely on the duration and intensity of the conflict, neither of which are clear at this stage. Mme Lagarde will likely want to deliver as neutral a message as possible. We do not have any strong views on Euro as of now but might like to receive 2 yr ESTR around 2.75 levels if available just before the policy event on 23rd July.

The “hall of mirrors” is a well documented problem in central bank communications. Rather than providing an independent signal about what a central bank should do, market pricing reflects a complicated feedback loop between central bank communications and economic fundamentals. The more the central bank tries to communicate how its reaction function depends on near-term developments, the more markets interpret these developments through the lens of that central bank’s reaction function. Financial markets perform best when they react to incoming data & they work less efficiently when they ask a question: How will the Federal Reserve react to that incoming information? Financial market prices are probably the most important source of information to guide central bankers. But when all the financial markets are doing is reflecting back what central bankers have said, then central bankers are blind to the most important set of information i.e true market information. Warsh believes in breaking this hall of mirrors. We believe Warsh might provide NIL forward guidance, might ensure DOTS go away while SEPs remain, post FOMC press cons to continue but far lesser content and that too on long term trends rather short term view & continuation of a more streamlined Fed speak. From a market perspective, with less forward guidance, term premiums go up and IVs remain elevated across asset classes.

At the monetary policy meeting held on 15-16 June, the BoJ raised the policy rate from 0.75% to 1%, the highest level since 1995, as expected. In its interim assessment of QT, it also decided to halt reductions to its JGB purchases from FY27 onward, after which monthly purchases will be maintained at around JPY2trn. This can be seen as a balanced choice vis-à-vis the Takaichi administration, which is reluctant to raise rates and concerned about a surge in long-term yields. Markets are currently pricing in a 92% chance of a 25 bps hike by Dec'26. We believe there is a significant risk of the next hike being in October itself. Governor Uchida characterized the current rate hikes as “policy adjustments toward a neutral level”, while adding that “it is not clear at what point we can judge the stance to be neutral; we won’t know until we reach it”. This likely implies that, although the policy rate has now reached the lower bound of the BoJ’s published estimates of the neutral rate, that fact does not mean the Bank will become materially more cautious about further rate hikes. As the situation in the Middle East seems to be stabilising, we believe uncertainty over the economy should recede, and the BoJ should ideally become even more focused on upside risks to inflation. In recent years, firms have become more accustomed to passing higher costs on to prices, and the BoJ should be strongly alert to the possibility that the mechanism through which higher crude oil prices lead to higher inflation has strengthened compared with the past. However, the rate-hike path could be affected by domestic and overseas political developments. In particular, if BoJ leadership proposes additional rate hikes going forward, we believe dissenting votes are likely to rise to four out of nine by July 2027, assuming PM Takaichi nominates doves to replace the Policy Board members whose terms expire on her watch. At the time of the September monetary policy meeting the BOJ will only have lending data for August, the first month when a June rate hike will start to be reflected in market interest rates and will not have any results from a Tankan survey carried out after the rate hike. As of September, the BOJ is unlikely to have enough data to assess financial conditions following a June rate hike. At the October meeting, however, when it will have access to lending data for several months following a June rate hike as well as to the results of the September Tankan survey, it will probably be able to conclude that funding conditions remain accommodative. But historically BOJ had decided not to hike rates in October 2025 or April 2026, we think it will be fairly difficult for the current leadership team to: (1) justify a rate hike after a shorter interval than before (2) without being able to confirm employers' stance on wage hikes. Hence, our main scenario for the next rate hike following a hike in June is a hike in December, while our risk scenario is a hike in October.

There were widespread expectations in the market that over time we would see meaningful changes to Fed communications, including around the meeting. And Kevin Warsh didn’t disappoint. We saw very, very significant changes to the range of communications at Chair Warsh's first meeting. We saw the statement completely trimmed down. And at least on the question of tone, it seemed like he very much leaned more towards the older version of Kevin Warsh when he was at the Board of Governors, where he seemed to be more focused on inflation and somewhat more hawkish signals from him. But we don’t know yet if this was just a role play to get in to the good books of FOMC members considering the baggage he comes with considering Trump’s rate cut ambitions. From a market perspective, market focus is shifting to US Fed reaction to elevated inflation than the Iran deal. The shift higher in economic forecasts and in the “dot plot” projections for the Fed funds rate this year were at the more hawkish end of expectations. While Warsh tried to downplay these somewhat in his press conference, the market has leaned into pricing hikes to materialise sooner, with USD rallying after the decision. The lack of forward guidance offered in either the Fed statement or by Warsh himself appears to be the new state of affairs and could create more room for front-end rates and FX volatility in the months ahead. Warsh had also announced the establishment of task forces focusing on five areas: Fed communication, balance sheet policy, the use of and reliance on existing data sources, productivity and jobs, and inflation frameworks. Although inflation risks are at the centre of discussion on the Committee, one of the above task forces is aimed at reviewing how the Fed should gauge inflation, suggesting that the bar to a hike might be higher until those task forces provide concrete policy proposals later this year. Summary: We still believe Fed is likely to remain on a long pause till Dec’26. But we don’t want to express this view yet via rates unless economic data starts changing. We do not see the current strength in NFPs fading at least till Aug NFP. Hence, we remain guarded on any strong rate views. But we remain bullish on DXY and expect it to go to 102 levels by July end from the current 100.85 levels. Also, if the 1yr-1yr US SOFR inches up to 4.10-4.15 levels from CMP of 4.03 levels, we like to receive half risk at these levels & another half at 4.25. Stop to this view is 4.35 and TP is 3.80.