Fresh Opportunities in USD/JPY?

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For the past 2 weeks, most investors have been focused on the upcoming U.S. elections, third quarter earnings and the sovereign debt crisis in Europe. These are very important issues that will continue to dominate the headlines and determine the overall direction for currencies but even with these big themes, we should not lose sight of what is happening in other parts of the world. Considering that the outcome of the elections and the path of Europe’s sovereign debt crisis are still uncertain, when governments are sending us a clear message, we should pay attention.

The Japanese government is telling us:

– The Performance of the Economy is Disappointing
– Worried About Deceleration in the Global Economy
– Fiscal Stimulus is on the Way
– They will Increase Pressure on the Bank of Japan to Ease

Last week, the Japanese government made it crystal clear that they are not satisfied with the performance of the economy and are ready to do more. Prime Minister Noda ordered his government to come up with a new round of stimulus measures by the end of November. The economy is weak and in dire need of more fiscal and monetary stimulus but the main motivation is the pending election. While Noda has until August 2013 to hold the general election, he promised the opposition that he would hold them sooner in exchange for their support of the sales tax increase earlier this year. However getting money for the stimulus program won’t be easy because the opposition party, which controls the upper house refuses to debate, let alone pass a bill that would allow the government to issue debt to finance the deficit. Without further cuts to spending and the ability to issue new bonds, the government will run out of the money in November. The only way for Noda to pay for the stimulus would be to tap reserves, reallocate money from special accounts in the budget OR get the Bank of Japan to ease.

Easier monetary policy from the BoJ is exactly what Finance Minister Maehara is hoping for and what the economy needs. Last week he said the economic stimulus ordered by the Prime Minister won’t rely on fiscal measures alone. He called for strong Bank of Japan easing and challenged the country to find ways to benefit from the strong yen. Having just increased monetary stimulus in mid September, the central bank may not be in a rush to increase stimulus because Quantitative Easing takes time to work its way through the economy. The Japanese Yen also declined in value since the last monetary policy meeting reducing pressure on the economy and in turn the central bank. The problem however is the Yen is still very strong and has contributed to a 10% decline in exports last month. While we believe that the BoJ needs to ease before the end of the year, it may not happen until their November or December monetary policy meetings. Not everyone believes that more stimulus will be the answer to Japan’s troubles. The Y19 trillion set aside for earthquake and tsunami rebuilding efforts have yet to produce tangible results. As the fight over the new bond issuance bill heats up, Japanese politics will become a greater focus for investors and political uncertainty is rarely good for a country’s currency.

Considering that the Yen is still a risk currency and the meltdown in stocks at the end of last week could lead to continuation this week, we believe that the most attractive opportunity is still in USD/JPY because other yen crosses are more vulnerable to equity weakness. There have been some nice improvements in U.S. data and while the slide in stocks could also drive USD/JPY lower, a move below 79 could be seen as a value opportunity. We believe the Japanese government won’t allow USD/JPY to drop below 75 and more likely not below 77. If the Federal Reserve recognizes the recent improvements in U.S. data or third quarter U.S. GDP numbers surprise to upside this week, USD/JPY could resume its rise. A break above Thursday’s high of 79.47, which coincides with the 200-day SMA should revive the rally, providing fresh opportunities in USD/JPY.

Kathy Lien
Managing Director

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