Japanese Data May Put Yen Back On The Block And Fuel Equities’ Decline

How Will The Markets React?

Global capital markets were shaken up pretty bad yesterday, but no region felt the pain as consistently as the emerging and developed Asian economies. Concerns yesterday that the Chinese government would step in to regulate investing facilitated through domestic loans triggered a chain reaction that reached every corner of the world as investors flooded out of assets conceived as risky. For the Japanese markets, Tuesday’s ripple progressed through time zones, and was at the door Wednesday morning when capital markets opened in Tokyo. For government debt and currency traders, deep liquidity buttressed further advances in the yen and 10-year JGBs. However, benchmark stock indices extended losses, leading some to believe that a retracement was finally relieving the pressure from what some analysts were calling overbought levels. Now local and foreign investors in Japanese assets will have to contend with two forms of risk: the threat of another wave of risk liquidation and an active economic calendar. On the back burner for most of the week, the fundamental docket will be hard to ignore now that markets are stabilizing. On Friday morning, the wires will glow red with employment, earnings, spending and inflation data. Direct inflation data will likely end up the least market moving. According to economists’ most recent predictions, both the leading Tokyo and lagging National price indices are expected to slow. Such an outcome would confirm BoJ Governor Toshihiko Fukui’s plans to move gradually on future rate hikes. More concerning for returns, consumer spending is projected to once again flounder. If exports begin to falter, the economy has little backup from domestic sources.

Bonds – 10-Year Japanese Government Bond Futures

Volatility in JGBs dried up Wednesday as investors put a plug in the broad flight to safety. Yesterday’s bar bears the scars of one of the most active sessions for Japanese assets in years in a large wick. Measuring nearly 45 points, the rally and subsequent retracement reveals how firmly set interest rate expectations are. When macro economic data comes back into the picture on Friday, the market will once again deem the significance of monthly inflation and consumer spending numbers in guiding expectations for monetary policy. For bonds, the data may fall on deaf ears though. After the Bank of Japan’s quarter point hike last week, Governor Fukui made it abundantly clear that a gradual pace would be taken. There is little reason to doubt this since government elections are just ahead.




FX – USD/JPY

After marking the biggest gains amongst the majors and the crosses, the Japanese yen was closely monitored Wednesday for any lingering symptoms that may have spelled out easy profit. An extension was not in the cards, however, as carry traders bought back into high yielding pairs and short-term traders jumped on the bandwagon for profits skimmed off of the retracement potential. Just like every other Japanese asset, the yen is still in a fragile state which would be easily upset if another wave of carry trade unwinding  built momentum. Considering that Tuesday’s move was triggered by a drop in Chinese equities and subsequent flight to safety from risky assets, it is not hard to see there is considerable trepidation amongst conservative carry traders. When all options are considered, the carry trade is a relatively low risk investment for big market participants who shun leverage for the easy yield collection.

Looking ahead, there are both technical and fundamental hurdles for the benchmark USDJPY to contend with. Looking to the charts, Tuesday’s low marks respectable support. Just below the intra-day low is a 61.8% fib retracement of the 114.44-122.19 bull wave at 117.41 and a 200-day simple moving average slightly lower at 117.39. Alternatively, resistance comes with the 100-day SMA at 118.86. While these are convincing technical levels in quiet markets, they will not be able to stand up to momentum based on further carry trade flows or a fundamental push. While it is difficult to determine when the next carry run will evolve, it is difficult to gauge the event risk in the economic calendar. On Friday morning, USDJPY will face inflation, earnings and spending reports. Of all the indicators on deck, the price gauges are expected to be the least market moving. After the central bank’s policy group boosted the overnight cash rate to 0.50 percent last week, many deemed it the last move until elections were over this summer. Instead, the consumer spending numbers, which could steer the economy toward consistent inflation, will likely guide the market. Both cash labor earnings and overall household spending for January are expected to improve upon previous period levels.




Equities – Nikkei 225 Index

Equities were the only Japanese assets that actually posted more volatility on Wednesday than the previous session. Stocks marked the biggest decline in eight months after the Nikkei 225 gapped 276 points (or 1.5 percent) lower on the open. In comparison, the Tuesday’s session was relatively stable. This suggests local investors were looking to the US markets for guidance on how to react to China’s unprecedented 9.2 percent stock market drop. If this is the case, then the Japanese stocks could be looking at a boost through Thursday’s session. Chinese officials said they would not impose capital gains taxes and will allow foreign investors to buy more stock as compensation for the pessimism that was driven by the crackdown on domestic investors who used loans to pay for their stock purchases. Also, though European markets were all under water for a second session, US indices closed the day modestly higher. In the days ahead, the Japanese market may determine its own fate. The expected outcomes for upcoming fundamental indicators could play out differently for share holders than traders in the debt and FX markets. Should both the Tokyo and National consumer price gauges slow as expected on the annual and core measurements, profit margins would benefit from cheap lending rates. At the same time, though the improvements in the domestic earnings and spending numbers are expected to be small, it will be another angle to draw investors into a market that seems to continuously make new highs. Alternatively, should the data disappoint, lingering uncertainty over the effects of the last rate hike could spread and lead to a serious correction of 10, 15 or even 20 percent.