Dollar Could Be the Key Driver to USD/JPY Trade

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Market Drivers April 03, 2013
UK PMI Construction lower than expected
Nikkei rallies hard but USD/JPY does not follow ahead of BOJ
Europe -0.31% Nikkei up 2.99%
Oil $96.80/bbl
Gold $1570/oz.

Europe and Asia:
AUD HIA New Home Sales -5.3% vs. 4.2%
AUD Trade Balance -0.18B vs. -1.0B
EUR Euro-Zone CPI Estimate
GBP PMI Construction 47.2 vs. 47.7

North America:
USD ADP Employment Change 8:15
USD ISM Non-Manufacturing Composite 10:00

Currency markets were relatively quiet in post holiday trade today, but EUR/USD popped to 1.2830 on news that the IMF reached an agreement with Cyprus and would invest 1 Billion euros to help resolve the fiscal and financial crisis in the country. As part of the agreement Cyprus will raise corporate taxes to 12.5% from 10% currently and will double personal taxes to 30% from 15% currently.

The steep austerity measures will no doubt take their toll on the small nation, but the market viewed today’s announcement with a modicum of optimism as it suggested that the crisis may be contained for the time being with little risk of further contagion to the rest of periphery Europe.

The credit markets have certainly been sanguine about the state of affairs in the Eurozone with both Italian and Spanish yields continuing to dip despite woeful economic data and little progress on the political front with Italy continuing to operate without a formal government. This relative ease in the credit markets has been one of the pillars of support for the EURUSD which has remained relatively stable despite a torrent of bad economic news.

Today latest release of inflation data showed that HICP remained at 1.7% as forecast and well below the 2.0% ECB target. The low inflation data readings suggest that price pressures in the EZ are non-existent and open the possibility for ECB to lower rates in order to stimulate demand. While the market doesn’t anticipate any change in policy at the upcoming meeting this Thursday, it will be interesting to see if Mr. Draghi hints at some potential flexibility on that front.

The economic situation in the EZ is clearly deteriorating with austerity policies an abject failure in the region. The monetary union is in desperate need of some stimulative policies to raise aggregate demand as it tries to return to positive growth in H2 of this year. That’s why Mr. Draghi’s presser tomorrow could be critical to the near term direction of the euro as the market looks for any solution out of the current economic malaise.

Meanwhile in Japan tonight’s first policy meeting of the new BOJ leadership could also prove market moving as traders await to see what steps Mr. Kuroda will take. As we have been noting, the BOJ needs to make some dramatic announcements in order to maintain the rally in USD/JPY which has lost considerable momentum over the past several weeks. The market expects the BOJ extend the duration of their purchases and to increase the size of the program by 30 billion additional dollars per month, but if the BOJ fails to enact even these two provisions the pair could tumble towards the 92.00 level on disappointment.

The other reason for recent USD/JPY weakness has to do with the USD part of the pair. At the start of the year US economic data suprised to the upside providing a consistent boost to USD/JPY rally. However, the most recent batch of reports has been disappointing and has capped any rallies in the pair. That’s why today’s ADP and ISM Services reports could prove crucial in North American trade. The markets are expecting little change in both reading from the month prior which would actually be positive given the string of disappointments over the past several days. However, if the numbers miss again, the downward pressure on USD/JPY could resume and the pair could drift towards 93.00 as the day proceeds.

Boris Schlossberg
Managing Director

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