Bank of Japan Meeting – Best and Worst Scenarios for the Yen

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Daily FX Market Roundup 10-29-12

Bank of Japan Meeting – Best and Worst Scenarios for the Yen
USD: Data Shows Spending Outpacing Incomes
EUR: Retail Sales in Spain Fall by Largest Amount Ever
GBP: Shrugs Off Strong Housing and Lending Data
USD/CAD Above Parity for First Time in 6 Months
AUD: New Home Sales on Tap
NZD: Shrugs Off Stronger Chinese Industrial Profits

Bank of Japan Meeting – Best and Worst Scenarios for the Yen

The most exciting event over the next 24 hours will be the Bank of Japan’s monetary policy announcement. While we have been skeptical of the central bank’s desire to increase asset purchases 2 months in a row, the market has priced in another round of easing. Last night we learned that Japanese retail sales fell 3.6% in September, compounding the troubles in Japan and reminding us of the rapidly deteriorating conditions across the nation. The Noda administration has a vested interest in getting the BoJ to ease ahead of the general elections because fiscal stimulus will be hard to come by but monetary stimulus will be far easier to achieve. While we believed that the BoJ would resist easing monetary policy 2 months in a row, now that the market has priced in the move, Japanese financial markets and the Yen could be punished hard if they don’t follow through. The Bank of Japan has a few options tonight and the reaction in the Yen will depend on which one it chooses:

Option A: Leave Asset Purchase Program (APP) Unchanged – Leaving their APP program unchanged would be the best thing the Bank of Japan can do for the Japanese Yen but also the worst thing possible for Japan’s economy and the Nikkei. Even if the central bank downgrades their inflation forecasts and economic assessment, implying that they would ease in November, the knee jerk reaction in the FX market would probably be Yen strength and more specifically a move down to 79.00 for USD/JPY.

Option B: Expand APP Program by Y10 trillion – If the Bank of Japan expands their APP program by Y10 trillion or the same increase as September which is what the market’s expects, the Yen will slide but not by much. The key is what the composition will be. In September, the BoJ split its purchases between JGBs and shorter term Treasury Discount Bills (TBs). If the composition is the same, USD/JPY will probably hold steady. If all they purchase are JGBs, it would be more aggressive than last month’s measures and probably more negative for the Japanese Yen.

Option C: Expand APP by Y10 Trillion AND Extend Purchases Beyond JGBs – If the BoJ expands their APP by Y10 trillion and expands their purchases to corporate bonds or ETFs, it would be even more negative for the Japanese Yen because the total size of asset purchases would exceed last month’s program. We will also be looking to see if the deadline of these purchases is extended beyond December 2012.

Option D: Option B or C AND Hardening of Commitment to 1% Inflation Target – What would be most bearish for the Japanese Yen and ensure a rise above 80 for USD/JPY would be an increase in the APP and hardening of the 1% inflation target. Currently the BoJ has committed to buying bonds until 1% inflation is on the horizon. If they harden their commitment by saying that they will make unlimited purchases of JGBs until 1% inflation is achieved, it would be the best case scenario for stocks and the worst case scenario for the Yen.

USD: Data Shows Spending Outpacing Incomes

Hurricane Sandy paralyzed the financial markets, leaving the U.S. dollar higher against all major currencies. U.S. stock markets will remain closed for trading on Tuesday, the first ever weather related consecutive close for the equity market in more than 100 years. With everyone in the Northeast corridor glued to the weather channel, it should be another quiet day for the FX market. Slightly better than expected U.S. data provided very little excitement but helped to keep the dollar bid against most major currencies. Personal incomes rose 0.4% in September, up from 0.1% the previous month and personal spending rose 0.8%, up from 0.5% in August. Incomes were right in line with expectations but spending grew at a faster pace last month, a trend that is not healthy for household finances but supportive for overall economy because consumers need to spend to get the economy going. Unfortunately the details of the report show real disposable incomes declining for the second month in a row and the savings rate dropping to its lowest level since November of last year. With the U.S. economy still growing at a lackluster pace and more consumers dipping into their savings to fund their spending, we could be looking forward to another challenging holiday season. The Conference Board’s consumer confidence index is due for release tomorrow and we expect an improvement after seeing sentiment increase according to the IBD and University of Michigan Consumer Sentiment surveys.

EUR: Retail Sales in Spain Fall by Largest Amount Ever

Despite the lack of major Eurozone and U.S. data, the euro ended the day lower against the U.S. dollar. Retail sales in Spain plunged 10.9% last month, the steepest decline on a record after the government raised the VAT tax 3 percentage points to 21%. Third quarter GDP numbers are due later this week and the data is expected to show Spain in recession. Based on the fall in retail sales last month, there’s very little chance the economy will be able to rise out of recession in Q4. This is a busy week for Spain. Aside from the GDP numbers, the country also has a major 20 billion euro bond redemption. According to the Spanish government, they are fully funded until the end of this year and the country hasn’t had any major problems attracting demand at recent auctions. Spain has been spared a junk rating from Moody’s, which will make it easier for the country to solicit funds. Despite the high level of debt in the Eurozone, most of the larger nations have not had major problems raising funds. There have been cases where higher yields were paid, but bid to cover ratios have been sufficient. As a result, we don’t expect any major shortfalls at upcoming auctions and there is every reason to believe that the bonds being redeemed in Spain this week will also be reinvested. The European Central Bank’s Outright Monetary Transactions program and more specifically their pledge to provide unlimited support for the Eurozone has been the given credit for stabilizing bond yields and reducing the liquidity concerns of highly indebted nations. This week, the ECB’s report on bank borrowing rates and lending standards (due on October 31st) will shed light on the influence of OMT. While the program can’t be activated until a country like Spain asks for help, if the ECB’s report shows improved banking behavior, we will know that OMT provided a psychological boost to banks. Nonetheless, a steep slide in Italian stocks and the overall weakness of European equities kept the euro under pressure throughout the European and North American session. After being convicted to 4 years of jail for tax fraud, former Italian Prime Minister Berlusconi threatened to withdraw his party’s support for Italian PM Monti, sending Italian stocks sharply lower. German unemployment numbers are due for release on Tuesday along with confidence numbers from the Eurozone.

GBP: Shrugs Off Strong Housing and Lending Data

Better than expected housing numbers failed to prevent the British pound from ending the day lower against the U.S. dollar and euro. An increase in mortgage approvals and lending to the household sector show low interest rates and the central bank’s Funding for Lending Scheme continuing to provide support to the housing market. Mortgage approvals rose to 50k last month, up from an upwardly revised 47.9k in August. Net consumer credit hit GBP 1.2 billion, its highest level since October 2008. Monetary Policy Committee member Broadbent was encouraged by the latest numbers but warned that it is too early to expect consistent improvements in credit lending. The latest improvements in data provide policymakers with more reasons to keep their asset purchase program unchanged next month. The CBI Distributive Sales survey is due for release tomorrow morning and we will be watching this report closely because it tends to have a strong correlation with the government’s official retail sales index.

USD/CAD Above Parity for First Time in 6 Months

The Canadian, Australian and New Zealand dollars ended the day lower against the greenback. Most of the weakness occurred during the European session, with commodity currencies remaining weak during the North American hours. Although Chinese industrial profits rose for the first time in 6 months, this increase provided very little support to commodity currencies. For the first time since August, USD/CAD rose above parity. No major economic reports where released from any of 3 commodity producing countries, but the weakness of the CAD is a reflection of risk aversion. Australia new home sales and Canadian inflation numbers will be released tomorrow but neither of these reports will be huge market movers for currencies. RBA Deputy Governor Lowe will also be speaking later this evening and comments on monetary policy could affect how the AUD/USD trades.

Kathy Lien
Managing Director

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