Japanese Yen Poised to Extend Gains as Risk Aversion Continues

Key Overnight Developments

• Japanese Employment, Manufacturing Figures Point to Slowdown
• Australian Bank Lending Grows Least in Seven Months on Rate Hikes
• Yen Outperforms as Carry Trades Follow Stocks Lower Overnight

Critical Levels

The Euro tracked lower overnight, down 0.2 percent against the US Dollar. The British Pound was little changed. We remain flat EURUSD and GBPUSD.

Asia Session Highlights

Japan’s Jobless Rate rose to 5.3 percent – marking the fifth consecutive increase – while preliminary Industrial Production figures showed output unexpectedly slumped 1.5 percent in June and the Nomura/JMMA PMI gauge showed manufacturing activity slowed for the second month in July. The outcomes follow a disappointing set of trade figures released earlier this week, reinforcing expectations of a slowdown in Japan’s export-driven economic recovery as overseas demand falters.

Meanwhile, price growth figures printed in line with economists’ forecasts, with the Consumer Price Index down 0.7 percent in the year to June to show the pace of deflation has fallen to the slowest in 14 months. Stripping out volatile items like fresh food and energy however, prices fell 1.5 percent, showing deflation remains a very real concern and assuring an accommodative monetary policy for the foreseeable future. Furthermore, renewed economic slowdown would renew downward pressure on the price level, hinting CPI readings may begin to turn increasingly negative in the months ahead.

Perversely, the Japanese Yen actually outperformed on the dour economic data, rising against all of its major counterparts, as the Nikkei led the MSCI Asia Pacific regional benchmark stock index lower in overnight trade, dragging carry trades funded cheaply in the perennially low-yielding currency along for the ride.

Australian Private Sector Credit figures printed weaker than expected, adding 0.2 percent in June versus expectations for a 0.4 percent increase, marking the smallest increase in seven months. Slowing bank lending growth likely comes on the heels of the central bank’s aggressive tightening campaign. Indeed, a single rate hike can take as many as six months to be fully absorbed into the economy, hinting underlying monetary conditions will continue to become more restrictive despite an RBA that has been on hold since May and bolstering expectations that Glenn Stevens and company will shy away from further rate hikes for the remainder of the year.

Euro Session: What to Expect

A preliminary estimate of July’s Euro Zone Consumer Price Index is set to show the annual inflation rate rose to 1.7 percent, the highest since November 2008. However, as with Germany’s CPI report earlier in the week, the outcome may not prove market-moving considering its limited implications for monetary policy. Indeed, price growth remains below the central bank’s 2 percent target level and monetary conditions have actually turned more restrictive in recent weeks, meaning Jean-Claude Trichet and company are surely in no hurry tighten.

Although the money supply expanded for the first time in eight months in June, that outcome did not take into account July’s expiry of the ECB’s 12-month repo – a lending facility allowing European banks to secure access to the central bank’s funds for a year – which amounted to large liquidity drain and put upward pressure on short-term borrowing costs. Indeed, European 2-year yields overtook those of the US for the first time in three months at the beginning of this month and now trade at a 26bps premium, meaning Euro Zone monetary conditions are at their most restrictive since mid-February.

With borrowing costs set to push higher still as governments issue debt to finance their gaping deficits and economic growth likely to slow amid a lurch toward austerity, the path of least resistance for the ECB points toward (at least) a static posture, with the possibility of renewed easing seemingly far greater than that of tightening.Rounding out the data, the Euro Zone Unemployment Rate is set to hold unchanged at a record-high 10 percent for the fourth consecutive month in June while German Retail Sales slip 0.2 percent, a seemingly tame outcome considering receipts surged 3 percent – the most in three and a half years – in the previous month.

Turning to risk sentiment, US equity index futures are trading sharply lower, down 0.5 percent and hinting the Japanese Yen will extend against the spectrum of major currencies as risk appetite continues to evaporate.

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