Yen Intervention Unlikely as Capex Soars, US Jobs Report on Tap

Key Overnight Developments

• Japanese Capex Soars in Second Quarter, Hints Yen Intervention Unlikely
• Euro, British Pound Consolidate as FX Markets Brace for US Jobs Report

Critical Levels

The Euro and the British Pound were little changed in overnight trade as currency markets consolidated ahead of the US Employment report, with traders continuing to look to the health of the world’s largest consumer market as the bellwether for the global recovery at large and, by extension, the trajectory of risk sentiment. We remain short EURUSD and flat GBPUSD.

Asia Session Highlights

Japanese Capital Spending outperformed, falling 1.7 percent in the year to the second quarter to record the smallest annualized drawdown in three years. Economists were forecasting a far larger 6.5 percent decline ahead of the release. In quarterly terms, spending surged 6.4 percent to mark the largest increase in four years. More encouraging still, capital investment by manufacturers – the drivers of Japan’s export-led recovery in the aftermath of the 2008 global downturn – soared 11.5 percent, the most in over nine years.

The outcome suggests Japan’s manufacturers are hardly burdened by the sharp advance in the Japanese Yen, with investment patterns pointing to a sector confident in future demand and poised to expand capacity. Indeed, although the nominal exchange rate is testing the lowest in 15 years, the real exchange rate tells a different story. In fact, the inflation-adjusted USDJPY exchange rate stood at 108.70 by the end of the second quarter having been 66.00 in the three months through June 1995 – the last time nominal rates were at current levels. Put simply, in real terms, the yen is 61 percent cheaper today than it was 15 years ago.

Real exchange rates are a better gauge of relative purchasing power than nominal ones, suggesting foreigners’ ability to afford Japanese-made goods is far greater than spot rates would imply. On balance, this hints that for all the talk of currency market intervention on the part of Japanese policymakers, traders are unlikely to see much more than jawboning for the time being.

Euro Session: What to Expect

Swiss Consumer Price Index figures are set to show the annual inflation rate held at 0.4 percent in August, matching a seven-month low recorded in the previous month. This amounts to a conflicting view on the likely direction of monetary policy going forward after yesterday’s stronger-than-expected economic growth figures for the second quarter. Indeed, Bruno Parnisari – an economist with the State Secretariat for Economic Affairs – told Bloomberg News after the GDP report that the economy is in “robust shape” and the government may revise up its full-year output forecast. However, the SNB predicted inflation at 0.85 percent through the third quarter; after readings of 0.4 percent in July and August, a near-2 percent surge annualized CPI would be needed in September to justify such a forecast, a clearly unlikely outcome.

All told, Switzerland is looking at a situation where apparently strong growth is not translating into inflation as capital fleeing from debt troubles in the Euro Zone pours into the Swiss Franc, sending the currency higher to finish August at a record high against a trade-weighted average of its top counterparts. The mountain nation’s reliance on exports necessarily suggests it lags importers in the global business cycle as its own rebound must wait for a recovery in overseas demand. While this means that Switzerland may appear resilient as other nations falter on the way into a slowdown, it equally looks weaker than others on the way to recovery. To that effect, the stellar second-quarter growth rate may not be sustainable after the Euro Zone – the destination for over 60 percent of Swiss exports – begins to feel the pressure from austerity measures and debt issuance as it tries to unwind its sovereign debt burden. Therefore, if inflation is hard to come by now, it will be all the more so in the second half of the year, threatening a return to deflation and opening the door for the central bank to consider a return to its policy of intervention into currency markets.

Elsewhere on the calendar, final revisions of Augusts’ Euro Zone PMI figures are expected to confirm initial estimates showing German service-sector growth accelerated to the fastest in three years while that of Euroland as a whole continued to flounder after topping out in May. As we noted yesterday, the increasing disparity between performance in Germany and the remainder of the currency bloc – a reality set to be underlined again with today’s results – underscores the inherent vulnerabilities of the common market as well as points to the likelihood of (at best) a static European Central Bank monetary policy for the foreseeable future. Separately, Euro Zone Retail Sales are expected to add 0.6 percent in the year to July, putting the annual growth rate at the slowest in three months.

Turning to sentiment, S&P 500 stock index futures are down 0.2 percent in late Asian trade, pointing to a cautious tone ahead of the release of US Employment figures due late in European hours.

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