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In the calm before the Bank of Japan’s (BoJ) storm, the FX market resembles a serene swim in tranquil waters, with the only ripple being a pre-BoJ dip into JPY. Recent USDJPY lows remain unbreached, offering a sense of stability.

Much of the chatter on trading desks revolves around the performance of US tech stocks. After a turbulent month, traders eagerly watch if Alphabet and Tesla can soar back to their highs after today's(tomorrow) earnings reports are released. A positive outlook from these tech giants might keep the FX market peaceful.

Despite the JPY’s appreciation, the USDJPY downswing hasn’t reached panic-inducing levels. This seems more like position squaring than a seismic shift in sentiment. However, some might read the tea leaves after LDP Secretary General Toshimitsu Motegi’s overnight declaration that the BoJ should clearly communicate its intent to normalize monetary policy. This follows Digital Transformation Minister Kono Taro's call for interest rate hikes to bolster the yen and reduce energy and food costs. The local sentiment is getting so restless that dual pricing for foreigners in Japan is being considered—a slippery slope that could have interesting repercussions.

Over the weekend, I speculated about a potential turning point for the yen, but we are far from testing the long-term carry trade threshold below 150 USDJPY. A return to the MXN/JPY carry trade could be conceivable in low volatility conditions, especially after the pair's recent steep decline due to US protectionist policies and anti-currency manipulation nuances from the Trump trade.

Despite the temptation, I remain cautious, focusing on de-risking and possible margin squeezes. Hence, I favor long JPY positions but not to the max, given the BoJ’s two-way risk, as highlighted in a Bloomberg article overnight. The article suggested that the BoJ might leave rates unchanged next week due to recent weakness in consumer spending.

Higher US equities typically dampen FX volatility, promoting the carry trade. While not evident today, it’s worth noting that another surge in US stocks could have interesting effects. Historically, rising US stocks would weaken the dollar through various currency risk betas. Still, with US AI stocks aiming for the stars and US commercial paper paying over 5.25%, there’s little reason to abandon long dollar positions just yet.

The BoJ's challenge ahead is significant. They need more than a rate hike to break down the massive carry wall. A substantial reduction in Japanese government bond purchases on July 31st is crucial; otherwise, USD/JPY could drift higher again.

The Euro is trading in a narrow range just under 1.09, with exceptionally low volatility—three-month volatility is at a mere 5.3%. The market seems to have concluded that there’s no trend here. ( ING Bank)  After Friday’s core PCE figure, the next significant input will likely be next Wednesday’s Fed meeting, which poses the only real adverse risk to the dollar unless the BoJ pulls an enormous rate hike rabbit out of the hat.

In summary, while the FX market enjoys a calm spell, the upcoming earnings reports from US tech giants, the BoJ’s policy decisions, and the Fed meeting will be crucial in determining the next moves. Stay tuned, as the tranquil waters might soon give way to more turbulent tides.

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