Dollar, Yen Recover as Bank of Japan Emergency Meeting Disappoints

Key Overnight Developments

• Bank of Japan Expands Credit Program to ¥30 Trillion at Emergency Meeting
• NZ Trade Balance Shows First Deficit in 7 Months, Business Confidence Slumps
• Australian Company Profits Soar Most in 9 Years, Home Sales Fall on Rates

Critical Levels

The Euro and the British Pound rose to start the week as rumors of an emergency Bank of Japan meeting boosted risk appetite but buying interest faded after the announcement fell short of expectations (see below). The single currency traded down 0.2 percent while sterling was little changed having tested as high at 1.5559 against the US Dollar. We remain short EURUSD and flat GBPUSD.

Asia Session Highlights

The Bank of Japan increased its bank lending program by 10 trillion yen to a total of 30 trillion and expanded the maturity of the loans to six months from three months at an emergency monetary policy meeting, saying the move will guide market borrowing costs lower. Policymakers noted that although the economy remains on the recovery path, more attention must now be paid to downside risks, adding that stock and currency markets have been unstable recently. Benchmark interest rates and monthly government were left unchanged at 0.10 percent and 1.8 trillion yen, respectively. The Japanese Yen spiked higher following the announcement, paring losses from earlier in the session, with traders apparently disappointed that the bank did not do something more substantial to check the currency’s gains and underpin the economic recovery. Indeed, boosting bond purchases would inject liquidity directly into the market, whereas extending bank credit lines may have little meaningful effect on monetary conditions absent lenders that want to take advantage of them as well as willing borrowers.

JapanesePrime Minister Naoto Kan is scheduled to meet BOJ Governor Maasaki Shirakawa today as he formulates the details of a new economic stimulus plan. A proposal drafted by the ruling DPJ party includes handouts for the purchase of homes and electronics, job-placement help for graduates, and aid for small- and medium-sized businesses affected by the Yen’s appreciation. DPJ policy chief Koichiro Gemba has said the government has about 910 billion yen left in the budget to finance the program. A final outline is due by August 31. New Zealand’s Trade Balance surplus unexpectedly narrowed, shrinking to NZ$573 million in the year to July. On a monthly basis, the report showed the first deficit in seven months and the largest since November 2009 as exports fell 5.9 percent while imports added 4.9 percent from June. The outcome may encourage the recent unwinding of RBNZ interest rate hike expectations, with the central bank opting to avoid anything that could strengthen the currency, making New Zealand goods comparatively more expensive to foreign buyers and hurting exporters, a critical growth sector accounting for over 30 percent of the overall economy. Indeed, a Credit Suisse gauge tracking the priced-in probability of a rate hike at the next policy meeting in September has now fallen for six consecutive weeks, with traders seeing just a 24 percent chance of a 25bps increase. Separately, a gauge of Business Confidence from the National Bank of New Zealand (NBNZ) fell to the lowest in 14 months

Australian economic data produced mixed results. Company Operating Profits surged 18.9 percent in the second quarter, topping forecasts nearly three-fold and marking the largest increase in over nine years. Miners companies led the way, with profits rising 62.7 percent from the three months through March. It remains to be seen however whether such stellar performance can be maintained as China – the mining industry’s top consumer – willfully slows its economy amid fears of asset bubbles and runaway inflation. Meanwhile, New Home Sales slumped 7 percent in July, marking the third straight decline, according to a report from the Housing Industry Association. The outcome likely owes to higher borrowing costs as the central bank’s aggressive tightening campaign that added 150bps to benchmark interest rates from October 2009 through May of this year filters into the overall economy.

Euro Session: What to Expect

The economic calendar is fairly uneventful in European hours. The final revision of Augusts' Euro-Zone Consumer Confidence gauge is expected to confirm initial estimates of a print at -12 while the Business Climate indicator edges higher to 0.70 over the same period.

Turning to sentiment, US stock index futures have turned lower ahead of the opening bell in Europe, trading up 0.4 percent having tracked as much as 0.8 percent higher in early Asia trade, after the Bank of Japan’s emergency meeting fell short of expectations. This points toward continued gains for the safety-linked US Dollar and Japanese Yen as risk aversion re-asserts itself. US Personal Income and Spending figures will be closely watched late into the session.

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