Why Moody’s May be Wrong on Japan

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Market Drivers December 1, 2014

Moody’s downgrades Japan A1 from AA3 USD/JPY drops nearly a figure
EZ PMIs mixed UK PMI
Nikkei 0.75% Europe -1.09%
Oil $65/bbl
Gold $1161/oz.

Europe and Asia:
CNY Final PMI 50 vs. 50
EZ Final PMI 50.1 vs. 50.4
UK Manufacturing PMI 53.5 vs. 53.1
UK Net Lending 2.6B vs. 2.8B

North America:
USD ISM Manufacturing 10:00

USD/JPY went on roller coaster ride in early European trade today after Moody’s cut Japan’s sovereign debt rating to A1 from AA3 citing uncertainty over Japan’s fiscal debt reduction program and its effect on growth policies.

In issuing its ratings cut Moody’s noted that Japan’s inflation targeting measures may put pressure on JGB yields while its growth policy poses risk to debt consolidation adding also that uncertainty persisted over the implementation of structural reforms in the economy colloquially known as the “third arrow” of Abenomics.

In expressing its concerns Moody’s reiterated many standard conventional economic critiques of expansionary monetary policy that is the the foundation of President Abe’s plan to stimulate the long moribund Japanese economy. Yet it remains be seen if Moody’s critiques have any merit. The ratings agencies have been notoriously wrong in their economic assessments of G-3 with their last blunder occurring in 2011 when S&P downgraded US debt only to see US fixed income complex stage a massive multi year rally.

As we’ve noted, there are several reasons to be more optimistic about Japan’s near term prospects including the sharp fall in energy price and the rise in the exchange rate which should provide export centric Japan with a modicum of stimulus going forward. Indeed today’s Q3 capex data which surprised to the upside could augur well for Q4 GDP rebound.

Meanwhile USD/JPY made a massive flip rising to 119.15 in the aftermath of the release only to plunge to a low of 118.07 before settling in the low 118.30’s. Although the knee jerk reaction is to always sell the currency after the sovereign debt downgrade the case with the yen is rather unique. Upon further reflection the market may have thought the rebuke from Moody’s may temporarily slow down Japan’s massive QE program which would in fact be negative for further USD/JPY gains. Although with more than 90% of JGBs in domestic hands, its doubtful if Moody’s warning will have much of an impact on the country’s sovereign debt market.

In any case today’s unexpected fireworks, provided a convenient excuse for some profit taking in the pair especially as it had risen closely to the key 120.00 mark during last week’s the holiday laden trade.

Elsewhere it was PMI day all over with Chinese final data coming in just a bit softer at 52.0 versus 52.1 for the official numbers while in Europe the EZ Final PMI readings in manufacturing slipped to 50.1 from 50.4 eyed as Germany dipped into contractionary territory for the first time since July of 2013. The only bright spot was in UK where the PMI readings popped to 53.5 from 53.0 forecast but here too price levels were at their lowest levels in 17 months suggesting that BoE will not face any inflationary pressures for a while. Cable managed to rally off the news rising above 1.5700 by late morning London trade.

In North America today the focus will be on the ISM Manufacturing data due at 1500 GMT. The market is looking for a slight dip to 57.9 from 59.0 the month prior but if the numbers surprise to the upside, USD/JPY could head right back to the 119.00 level as the day proceeds.

Boris Schlossberg
Managing Director

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