Japan’s controversial new sales tax got a vote of confidence from Bank of Japan Governor Kuroda overnight, and USDJPY broke through the key 100.00 level in the aftermath of the comments.

The USDJPY broke through the psychologically important 100.00 level today as Bank of Japan (BoJ) governor Haruhiko Kuroda assured the markets that the central bank will offset any adverse effects of the proposed new sales tax with more aggressive monetary policy. In the BoJ press conference following the monthly meeting, Kuroda noted that the central bank saw no need to take further action now, but that it stands ready to provide more liquidity should the Japanese economy begin to slow once again.

It appears that Japanese policymakers are coming to the conclusion that the national sales-tax hike to 8% from the current level of 5% will indeed take effect. Officially, the Japanese government noted that the final decision will be announced by Prime Minister Shinzo Abe at the start of October, but Kuroda's remarks today left no doubt as to where he stood. The BoJ chief noted that markets needed to see some fiscal discipline and would lose trust in the Japanese government if the sales tax plans were delayed.

It is clear that Japanese monetary officials are afraid that expansionary monetary policy without simultaneous fiscal tightening could wreak havoc in the Japanese government bond (JGB) market, but by arguing for the sales tax now, they risk snuffing out the country's nascent and fragile economic recovery. Although economic activity has definitely improved, with unemployment at five-year low and capital expenditures turning positive, final demand remains relatively weak, and any increase in taxes could have serious dampening impact on consumer spending.

By mid-morning London dealing, much of the enthusiasm over Kuroda's comments had faded, and USDJPY drifted back below 100.00 as profit taking kicked in. The rally in the pair can only be sustained if US economic data comes in better than expected, convincing the market that the Fed taper will be announced soon, which in turn should help US Treasury yields to rise.

To that end, today's ISM services report is likely to be crucial to the near-term direction of USDJPY, with traders focusing primarily on the employment subcomponent in order to get a better reading on the non-farm payrolls (NFP) data due tomorrow.

USDJPY is also caught in a seesaw battle between relatively buoyant US economic data and the specter of geopolitical risk as the situation in the Middle East grows more perilous. Today's news that the Egyptian minister of the interior narrowly escaped an assassination attempt shows that the whole region—not just Syria—is a cauldron for turmoil that could quickly spark risk-aversion flows in the capital markets. Therefore, USDJPY may continue to be pushed and pulled by these two opposing forces for the foreseeable future.

The Critical Event Risk in Europe

In Europe today, all eyes are on the European Central Bank (ECB) press conference, although few market participants expected any news from ECB President Mario Draghi and company going in. The ECB chief will no doubt reiterate the notion that interest rates will remain low for the foreseeable future, even as the Eurozone economy has shown signs of recovery.

However, if he demurs on the prospects for negative interest rates given the clear improvement in Eurozone economic activity, the EURUSD may see a bit of a boost and trade back towards the 1.3250 level.

By Boris Schlossberg of BK Asset Management