Will BoJ Save or Kill the Yen?

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Daily FX Market Roundup 12-19-12

Will BoJ Save or Kill the Yen? 4 Scenarios
USD: Optimism Sapped by Fiscal Cliff Fears
GBP: BoE Worried about Growth and Inflation
NZD: Growth Slows
AUD: Hit by Weaker Data
CAD: Retail Sales on Tap

Will BoJ Save or Kill the Yen?

The most exciting event risk over the next 24 hours will happen during the Asian trading session. Tonight, the Bank of Japan will wrap up its 2 day meeting and announce their decision on monetary policy. In anticipation, the Japanese Yen has fallen to its lowest level in more than 1.5 years. While USD/JPY and most other Yen crosses ended the North American session well off its highs, the recent sell-off in the Yen has been driven by expectations of easier monetary policy from the Bank of Japan. Since the last monetary policy meeting in November, Japan’s trade deficit almost doubled as exports plunged 4.1%. Japanese manufacturing activity slowed, causing manufacturers’ sentiment to deteriorate further. Retail sales rebounded but not by as much as economists had hoped as consumer confidence weakened. In other words, the central bank’s 10 trillion yen increase in asset purchase in September had very little impact on the economy. Perhaps it can be argued that without this support, the economy would have performed worse but regardless, the data shows that the economy needs more help. For this reason, the sell-off in the Yen indicates that investors have priced in another round of easing from the BoJ. With Yen shorts are at their highest level since 2007, increasing asset purchases by 5 to 10 trillion yen may not be enough to fuel a further rally in USD/JPY. Here are some of the central bank’s options and the potential impact on the Japanese Yen:

Option #1 – Increase Asset Purchase by 5 to 10 Trillion Yen, No Further Comments >> Neutral for USD/JPY

The Bank of Japan may actually end up saving the Yen if they do no more than increase asset purchases by 5 to 10 trillion yen. Not only is it what the market expects, but the lack of willingness to go above and beyond suggests that the BoJ is trying to protest pressure from the LDP. While Shirakawa is slated to step down in April anyway, if he continues to butt heads with Abe, Japan may not receive the monetary support it needs between now and then. However we think this scenario is less likely than #2 or #3.

Option #2 – Increase Asset Purchase by 5 to Trillion Yen, Commit to Doing More >> Mildly Positive for USD/JPY

The most likely scenario is to give the market exactly what it wants and to leave them hanging for more. There’s no question that Japan’s economy needs more help and Shirakawa wouldn’t be doing his job if he didn’t promise to continue to provide more support if the outlook worsens. By committing to do more in 2013, Shirakawa would leave investors would some hope of open ended purchases or a higher inflation target next year which should be mildly positive for USD/JPY.

Option #3 – Announce Open-Ended Asset Purchase Program >> Positive for USD/JPY

Shifting to an open ended asset purchase program similar to the one adopted by the Federal Reserve would represent a step up in monetary easing for the BoJ. With their current programs having very little impact on the economy, we believe the BoJ could choose to be a bit more aggressive, which should not only be enough to drive USD/JPY to 85 but take the pair even higher.

Option #4 – Increase Asset Purchase, Target 2% Inflation >> Extremely Positive for USD/JPY

The final and most nuclear option that the BoJ could take tonight is to change their inflation target from 1% to 2%. Given the political differences between Shirawaka and Abe, we are not sure if he will bend to the demands of the LDP leader. If he acquiesces however, it will be extremely positive not just for USD/JPY but all of the Yen crosses.

USD: Optimism Sapped by Fiscal Cliff Fears

Investors are finally waking up to reality and realizing that the risk of the U.S. economy falling off the Fiscal Cliff is extremely high. Politicians are doing nothing more than throwing out proposals that they know will be rejected swiftly by the other side only to avoid being blamed for causing the Fiscal Cliff when the year comes to an end. Today, the White House said President Obama plans to say no to House Speaker Boehner’s proposal because it places too much burden on the middle class. Considering that the President still wants a deal by Christmas, which is only 3 working days away, expect Fiscal Cliff headlines to continue to drive volatility in the financial markets. The U.S. dollar ended the day slightly lower against European currencies and higher against the Japanese Yen and comm dollars. Mixed U.S. housing market numbers did not stop USD/JPY from rising to its highest level since April 2011. Housing starts fell 3% but building permits rose 3.6% to its highest level since 2008. Overall the housing market continues to benefit from low interest rates but the pace of the U.S. recovery has hampered the momentum. Even though starts declined, the deterioration represented a pullback after a strong October. The final release of Q3 GDP, jobless claims, Philadelphia Fed survey, existing home sales and leading indicators are scheduled for release tomorrow. We expect mixed results with claims rising after last week’s sharp decline, existing home sales increasing, manufacturing activity deteriorating and GDP revised slightly higher on stronger consumer spending.

EUR: Major Intraday Reversal

After rising to an 8 month high at the start of the North American trading session, the EUR/USD staged a dramatic intraday reversal that stripped a majority of the currency pair’s gains. The turnaround was caused by none other than renewed anxiety about the U.S. Fiscal Cliff as Eurozone data continues to ease the minds of investors and lend support to the euro. German businesses grew more optimistic according the expectations component of the IFO report, which rose to its highest level in 7 months. Current conditions may have deteriorated but business climate and outlook improved, which are signs that the German economy could be regaining momentum. Part of the reason why the Bundesbank downgraded its GDP forecasts was because they expected sentiment would remain weak for a longer period of time but between the higher ZEW and IFO reports, the economy may not slow as much as policymakers fear. The Eurozone current account surplus also increased in October, reflecting an improvement in external demand. German producer prices is the only piece of Eurozone data on the calendar on Thursday but EU Commissioner Alumnia will be announcing decisions on state aid for Spanish Banks. Swiss trade numbers are also scheduled for release and a smaller deficit would validate the Swiss National Bank’s continued intervention.

GBP: BoE Worried about Growth and Inflation

The British pound ended the day unchanged against the U.S. dollar and euro after the Bank of England minutes revealed no major changes to the central bank’s bias. According to the minutes, MPC members voted 8 to 1 to keep their asset purchase program unchanged. The lone dissenter continues to be David Miles who has consistently voted for more Quantitative Easing. For the BoE, their challenge is to manage monetary policy during a period of stagnant growth and rising inflationary pressures. The central bank was less concerned about international conditions but worried about the high level of the GBP/USD. This summer, the U.K. economy benefitted from many one-off factors such as the Queen’s Diamond Jubilee and the London Olympics. Slower growth is expected this quarter as the economic contribution from those special events fade. The central bank is still worried about higher inflationary pressures and with energy companies expected to increase prices, the fear of inflation could deter further monetary policy actions. Retail sales are due for release tomorrow and based on the sharp decline in the CBI Distributive Trades survey, consumer spending may not rebound as much as economists expect but stronger consumer confidence could keep demand supported. Retail sales declined 0.8% in October and are expected to rise 0.4% in November.

NZD: GDP Growth Slows

Commodity currencies continued to lose value against the U.S. dollar with NZD/USD experiencing the greatest losses. Between November 16th and December 17th, the NZD/USD experienced the strongest gains and now what has risen the fastest is also falling the quickest. Another round of weaker economic data led investors to believe that the New Zealand dollar does not deserve its lofty valuations. While the Reserve Bank is comfortable with the current level of monetary policy and unconcerned about the rise in its currency, on a purchasing power basis the NZD/USD is more than 30% overvalued. With GDP growth slowing in the third quarter to 0.2% from 0.6%, the RBNZ may have to reconsider its stance, especially if the region is hit by weaker growth from China. The Australian dollar fell victim to softer data – leading indicators growth slowed to 0.1% from 0.6% in October while skilled vacancies fell 3.5% in November. Canadian data on the other hand was mixed. Wholesale sales rebounded 0.9% in October but house prices dropped 0.4% last month. Retail sales are due for release tomorrow and based on the recovery in wholesale sales and strong employment numbers, we expect consumer spending growth to accelerate.

Kathy Lien
Managing Director

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