The bullish momentum that lifted markets at the start of this week appears to have tapered off. Very little movement in stocks over the last session and judging by the economic calendar there is not much to suggest that big moves are on the horizon.

Even commodities are relatively range bound so far this week. With no new geopolitical developments, oil prices have stabilised somewhat at $83 and $78 a barrel for Brent Crude and WTI respectively. Gold continued to hover around $2,300 an ounce.

We had some movement in currencies yesterday; the Dollar gaining over most other majors. Losses in the Japanese Yen and the Pound were the main contributors as the DXY gained 0.28% on the day. The moves in Cable precede the Bank of England’s monetary policy report set to be released on Thursday along with the latest interest rate decision. Although very few are expecting any change from the current 5.25% target, the report may give some clues as to which way the weather vane is pointing. The theorised intervention by the Bank of Japan to support its currency last week doesn’t seem to have had any long-lasting effects – the pair is already creeping back up and reclaimed 155 Yen at the time of writing.

One market that has flown under the radar this year is Hong Kong’s Hang Seng Index, which has received a breath of life following strong commitments from the government to rectify certain aspects of the Chinese economy. The index is now up 25% since the lows of January.

Good news - but not for American job seekers. Non-Farm Payrolls figures published last Friday revealed lower than expected new jobs in April: 175k versus a consensus of 243k. Unemployment also rose to 3.9% compared to the previous data print of 3.8%. The numbers give hope that the US labour market is not overheating after all, and that interest rate cuts are still very much on the table. The only missing piece is for inflation to start cooperating. Figures published so far have been consistently high, to the dismay of many Federal Reserve board members.

US stocks were thrilled with the unexpected development. The Nasdaq Composite in particular closed just shy of 2% higher on Friday, the S&P 500 gained 1.26% and the Dow Jones Industrial Average finished the day 1.18% in the black. Understandably, the Dollar was not so enamoured with the narrative shift, the DXY wicked sharply to the downside during the session before closing the day a quarter of a percent lower. Gold remained unfazed, oscillating around $2,300 an ounce throughout most of last week before closing flat on Friday. The one outlier in commodities was oil, which lost around 6% last week, affected mostly by demand concerns as a result of reduced growth forecasts around the world, as well as a lack of further escalation between Iran and Israel.

There is very little on the economic calendar to get excited about this week. Market participants will have to wait until Thursday for the only items of any real substance, which include more interest rate talk from the Bank of England and the ECB, followed by US jobless claims.

It’s time to talk about the Japanese Yen. Traders may have noticed the violent movements in USDJPY over the last few sessions. Longer term investors may have had the pair on their radar for a while, wondering whether there will ever be a trend reversal. So what’s going on between the Dollar and the Yen?

The crux of the issue is that interest rates on the Dollar are around 5.5%, whereas rates on the Yen are essentially zero. This presents an opportunity, for those in a position to exploit it. The opportunity is known as the carry trade. The carry trade involves borrowing the Japanese Yen at low cost, then investing the borrowed funds into currencies with a higher yield. The spread between the different interest rates dictates the profit margin.

In the case of the Japanese Yen and the United States Dollar, the spread is high enough to warrant a lot of attention in the world of finance. Investment firms borrow the Yen and buy the Dollar, benefitting greatly from the high yield offered by the greenback. This increases the price of the Dollar relative to the Yen, and this has been the main driver behind the surge seen in the USDJPY pair. The problem is that as long as the difference in interest rates persists, so does the selling pressure on the Yen.

But why are the respective interest rates so different in the first place? We need to take a step back in time in order to answer this. Economically speaking, Japan and the USA are in very different situations. The Japanese economy utterly collapsed in the early 1990s, following forty years of extreme growth. The decades of stagnation that ensued forced the Bank of Japan to lower interest rates on the Yen to non-existent levels in order to inject money into their banking system. The framework of monetary easing was designed to stimulate borrowing and investment, encouraging new growth in the beleaguered economy.

The results were mixed. Although the Japanese stock market eventually went on to reach fresh highs, the economy itself never convincingly gained any upwards momentum. This leaves the Bank of Japan with very few options. Any increase in rates will smother what fledgling growth has been achieved so far. The central bank needs to see progress in the form of higher wages, price inflation and economic expansion. So far, the signs are just not there, hence the current target rate of zero.

Now for the United States. The US economy experienced a small recession in 2020. To counteract this, the Federal Reserve lowered interest rates to zero, with the same purpose of stimulating borrowing, investment and growth. It worked. The American economy experienced a strong rebound, so much so that both the labour market and inflation figures started to show signs of overheating. This time, the response was to do the opposite and raise rates until the economy cooled off, hence the current 5.5% target rate.

This is how we arrived at the current situation, but what comes next? At this point, it may be worth reflecting on the consequences of having a weaker currency. Who cares if the Yen declines versus the Dollar? On the one hand, a weaker currency helps tremendously with the export market. Japanese goods become cheaper on the world stage, increasing money inflows into the economy, boosting local growth. A weaker currency also helps to pull in tourists, lured by the attractive exchange rate.

On the other hand, a weaker currency makes everything imported into the country more expensive. This includes very important things, such as oil. For a nation such as Japan, which is entirely reliant on oil imports, this presents a problem. Higher energy costs are obviously very detrimental to industrial production, potentially leading to cost-push inflation, which is what occurs when it becomes more expensive to manufacture goods. Unless the extra growth achieved thanks to higher exports is enough to cover the added expenses of manufacturing the goods, then there is a problem.

What is the Bank of Japan supposed to do? As we said previously, any rate hike would hinder the little economic growth achieved so far. Besides, even if rates on the Yen were allowed to rise to let’s say, one percent, the spread is still high enough to justify the carry trade. The gap would need to be closed considerably, which the BoJ simply cannot do.

Another possibility is for the Bank of Japan to buy the Yen on the open market, selling its foreign reserves in exchange. Judging by the sharp sell-off in USDJPY this week, this may well have already occurred. Changes in the bank’s current account balance appear to be confirming this theory, although markets will have to wait for any official confirmation.

Japan’s problems are exacerbated by the fact that the United States Federal Reserve continues to push interest rate cuts further down the road, meaning the pressure on the Yen is maintained for longer. Not an enviable situation for anyone.

The above explains the situation from the Japanese perspective, but misses something vital. The whole point of the carry trade is to use the cheap Yen to purchase currencies and assets abroad. What happens when this trade unwinds? All that cash will have to be paid back at some point; all the liquidity pumped into foreign assets must be repatriated back to Japan. What happens to the prices of those foreign assets when the time comes to cover the bill? Stock markets around the world beware.

Moreover, returning to the Japanese perspective one last time, what happens to the price of the Yen when the world rushes back into it to repay their loans? Any reversal in trend in USDJPY will trigger a rush to the exits as people sell their foreign reserves to buy back the borrowed Yen. If there is one undeniable truth behind all of this, it is that the world economy has never been more intertwined.

Markets experienced some measure of volatility over the past few sessions but ultimately stayed range-bound ahead of Non-Farm Payrolls later today. Jerome Powell’s comments earlier in the week reassured traders that an interest rate hike remained very unlikely, but some of his other comments continued to downplay the prospect of rate cuts any time soon. In no uncertain terms, the Federal Reserve Chair stated that inflation is still too high and that "further progress in bringing it down is not assured and the path forward is uncertain". Essentially, rate cuts are delayed, not cancelled.

The Dollar Currency Index showed some signs of weakness over the past two days but remains firmly above the 105 level for the time being. One contributor to the downwards pressure on the DXY is the sudden strength observed in the Japanese Yen. USDJPY fell a solid 2% on Wednesday, followed by a further 0.67% over the next session. A quick glance at the chart suggests the Bank of Japan may have finally stepped in to defend its currency against any runaway price action, although markets will have to wait for any official confirmation.

Appetite for further confrontation in the Middle-East continued to dissipate this week and with it any fundamental support for crude oil prices. Brent Crude fell below $84 a barrel on Wednesday, WTI now hovering around $78. Gold seems to have lost momentum one way or another for now, content to consolidate around $2,300 an ounce.

A roller-coaster week for stocks ended with even more drama last Friday, as Google and Microsoft published stellar earnings reports that were good enough to lead a market-wide rally. Tech stocks in general performed well, as evidenced by the Nasdaq Composite gaining a full 2% on the day. The S&P 500 lagged behind but still climbed a respectable 1% by the closing bell; the Dow Jones Industrial Average closed 0.4% higher.

On the other side of financial news scale, PCE numbers dropped on Friday, to little surprise overall. The Fed’s preferred inflation metric revealed a year-on-year increase of 2.8% versus expectations of 2.6%, while the month-on-month figures fell exactly in line with consensus at 0.3%. While only a small deviation, market participants are understandably becoming more and more sceptical of just how much of an interest rate cut we will see this year. Speaking of which, the Fed is due to announce an interest rate decision on Wednesday; no change from the current rate thoroughly priced in.

The Dollar seemed to capitalise on the sentiment, climbing half a percent on Friday, the DXY doing just enough to reclaim 106 points. Gold appeared content to remain out of the spotlight throughout most of last week, moving very little after Monday’s initial drop.

Strength in the Dollar contributed to woes in the Japanese Yen, which saw its exchange rate collapse on Friday, blasting through 156 and then all the way up to 158. The wording from the Bank of Japan last week inspired confidence in no one. The country’s central bank lowered its forecasts for economic growth this year, while data revealed lower than expected inflation figures for Tokyo. Given the huge discrepancy in interest rates between the Yen and the Dollar, traders see little reason to favour the former over the latter.

Troubling US economic data hammered stock prices lower on Thursday after Q1 GDP figures came in lower than expected at just 1.6% against a consensus of 2.5%. A worrying statistic in its own right, but further exacerbated by an unexpected increase in Core PCE Prices, which grew 3.7% in the first quarter of the year, also beating estimates. The combined figures paint a rather bleak picture as far as inflation is concerned. At the risk of stating the obvious, higher prices coupled with stagnant growth is not really on anyone’s wish list, and certainly not on the Federal Reserve’s.

Major indices opened low before spending most of the day clawing their way back up to somewhat more respectable levels. The Dow Jones was the hardest hit, keeping its neck above the 38,000 level to clock a rather pitiful 1% loss. The Nasdaq Composite did what it could but ultimately finished the session an uninspiring 0.64% in the red. The S&P 500 briefly dipped below 5,000 points before closing just under half a percent lower.

To add insult to injury, some of the earnings reports published this week have not exactly made for confidence-inducing reading. Meta revealed exorbitant operating costs that raised more questions about the company’s capacity to generate revenue, causing shares to plummet over 10%. Tech stocks in general suffered moderate losses as Microsoft, Alphabet and Amazon faced selling pressure.

Inflation fears pressured the Dollar slightly, pushing the DXY down a quarter of a percent, although currency traders are probably waiting for the Core PCE Price Index to drop on Friday before making more substantial bets. The Fed’s preferred inflation metric will no doubt shed more light on the developing stagflation narrative.