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The Tough Combo That Could Undermine "Abenomics"

The Tough Combo That Could Undermine "Abenomics"

Boris Schlossberg, Technical Strategist

The combination of Japan’s proposed sales tax increase and slow economic growth from around the world now threatens to erase the positive impact of Prime Minister Abe’s aggressive stimulus measures.

The US dollar (USD) continued to drift lower at the start of this week's trade as the high-beta currencies were boosted by a smattering of economic and M&A news, while USDJPY gave up a big part of its early gains. USDJPY initially soared on the double whammy of positive news, as Tokyo won the bid to host the 2020 Summer Olympics and Japanese GDP rose at an impressive 3.6% annual rate.

The pair rose to a high of 100.11 after positive sentiment and risk-on flows helped fuel the rally. However, the move quickly fizzled once attention turned back to the issue of the national sales tax, which is expected to be raised to 8%.

Today's Parliamentary panel on the sales tax issue showed that lawmakers offered no objections, with Liberal Democratic Party (LDP) members Noda and Miyazawa stating that no one on the panel urged rethinking of the policy change.

The market will now await the final decision of Prime Minister Shinzo Abe about whether to proceed with the tax hike, which is expected to be announced at the start of October after the results of the Tankan survey. More than any other Japanese policy official, Mr. Abe has been reluctant to enact the increased sales tax while fearful that it will dampen newly recovering Japanese consumer demand.

See also: A Japan Policy Move Sure to Prove Taxing

Indeed, while today's Japanese GDP data showed an impressive 3.6% annual growth, the gains were spurred by capital investment, while consumer sentiment, as measured by the Eco Watchers survey, actually declined a bit to 51.2 from 52.3 the month prior.

Although “Abenomics” has certainly had a positive impact in reviving the Japanese economy, there is a very real danger that the combination of a sales tax hike and slowing global growth could undo much of the recent gains.

3 Majors Rallying vs. the Dollar

Elsewhere, the euro (EUR) strengthened and EURUSD moved towards the 1.3200 figure after the Sentix investor survey rose to 6.5 from -4.0 expected. It was the survey’s best reading since May 2011.

The British pound (GBP) also moved higher, boosted by M&A flows from the Suntory-GSK deal, while AUDUSD cleared the .9200 handle on the back of favorable Chinese trade data over the weekend and the solid home loan data.

The victory of the right-leaning Liberal Party over the weekend was also seen as a positive step, with new Australian Prime Minister Tony Abbott vowing to roll back the mining and carbon tax.

The “2 Dominant Themes” in the US

With no data on the US economic calendar, trading may remain quiet as markets continue to speculate on the two dominant themes, those being Syria and Fed tapering. However, with no major announcements from either Washington or New York expected today, price action is likely to remain muted.

By Boris Schlossberg of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.