Global FX markets remain relatively quiet, with the dollar showing slight strength during today’s Asia session. This uptick is driven by a surprise bounce in US May consumer confidence and a slight increase in US yields following some tepid auctions of two- and five-year US Treasuries. Tonight, $44 billion of seven-year US Treasuries will be auctioned.It seems paradoxical that the US dollar is strengthening despite the government facing challenges in funding through these auctions. This could become a more prominent issue later in the week if subsequent bond auctions also struggle. For now, the dollar benefits from higher yields, but if these yields are primarily a result of weak bond demand, the relationship might weaken over time.The yen feels the heat as traders flock to the carry trade, drawn in by the low FX volatility siren song. EURJPY is over 170, and GBPJPY is trading + 200; it’s like the yen has wandered into a heavyweight match, and it’s taking some serious hits.The Bank of Japan (BoJ) faces mounting pressure to enter the ring. The 2-year JGB yield has leaped 3 basis points to 0.37%, its highest since June 2009, thanks to BoJ Board Member Seiji Adachi, who hinted that a rate hike might be the BoJ’s secret weapon to combat yen weakness if it starts messing with inflation. The BoJ’s NEER is down nearly 8% from its January peak, making it hard for the BoJ to ignore that the yen’s slide might be pumping up inflation more than they thought.With a July rate hike now looking like a hot favourite, FX traders are looking at a 15 basis point increase. It’s like watching the BoJ prepare for a dramatic showdown, ready to boost the yen. The yen’s tumble might be wild, but the BoJ is finally gearing up to hit back.One roadblock for the Bank of Japan is dislodging Mrs. Watanabe and the hedge funds from their beloved carry trade. This could become a significant issue if US yields keep climbing, making the sell USD/JPY signal less about the slight incremental upticks in JGBs and more about the broader appeal of higher US returns.Mrs. Watanabe—Japan’s legendary retail investor—and a horde of FX  hedge funds have been enjoying the carry trade, where they borrow yen at low interest rates to invest in higher-yielding currencies. The BoJ’s task of prying them away from this lucrative setup is like trying to get a cat to give up a sunny windowsill. It won’t happen without a compelling reason, like a definitive drop in US yields and a more aggressive policy response for the BoJ More By This Author:Tech Booms As HIgher Treasury Yields Loom
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