What to watch in Europe and Japan this week

February 24, 2014 — Mitul Kotecha

European equuty markets ended higher last week shrugging off some disappointing manufacturing and service sector survey readings. The highlight of the Eurozone calendar this week is today’s release of the February German IFO business confidence survey which is expected to register a small increase from the 110.6 reading in January, supporting the message that German growth is consolidating over Q1 14.

Eurozone inflation readings will be important too, with the flash reading of February HICP inflation released at the end of the week set to record another soft reading of 0.7% YoY, supporting the case for further policy easing from the European Central Bank soon.

While the EUR may benefit from a firm IFO reading any gains will be short lived. Soft inflation will help cap gains in the currency especially given the renewed warning this weekend by ECB President Draghi of more policy action if needed.

Elsewhere, data this week will reveal that the main measure of Japanese inflation appears to be peaking around 1%, with core inflation set to decline over coming months. After last week’s softer than expected Q4 GDP reading the pressure on the Bank of Japan for monetary action and in turn a weaker JPY will continue.

Meanwhile, Japan’s job data is expected to reveal that the unemployment rate held steady at 3.7% in January. USD/JPY will remain support around its 100 day moving average at 101.65.

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USD/JPY edging higher

February 18, 2014 — Mitul Kotecha

The release of a much weaker than expected print for Japan’s Q4 GDP placed today’s BoJ meeting in a different light. While there was very little expectation of any policy action by the BoJ today the Bank surprised by increasing its lending program.

While asset purchases were not increased it is unlikely to be long before the BoJ embarks further along this path too. Clearly as the GDP data shows the task to boost growth / end deflation is going to be tough especially given the upcoming consumption tax hike. In other words the potential for future action remains significant.

USD/JPY fell initially on the BoJ outcome but pushed higher after an initial disappointment. The recent widening in the US / Japan yield differential (10 year differential at 224 basis points) indicates that USD/JPY will be supported on the upside, with support around 101.38.

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Positive tone to be sustained

February 18, 2014 — Mitul Kotecha

A quiet start to the week following the President’s Day holiday in the US saw mixed performances among European equity markets overnight. There was however, a continued improvement in risk appetite as indicated by a further decline in the VIX “fear gauge”.

The impulse provided for today’s sessions is limited although markets are likely to get off to a positive start. The USD managed to show some stability following recent pressures, albeit at a low level, while gold prices remained supported above the key 200 day moving average level.

The main event today is the Bank of Japan policy decision which will be watched closely following yesterday’s release of disappointing Q4 GDP data.

The German February ZEW survey is also on tap, with a relatively stable reading likely to be registered although attention appears to be more on the new Italian Prime Minister Matteo Renzie rather than on economic data.

Additionally UK inflation data for January is set to reveal that inflation has dropped below target highlighting that the BoE is going to be in no rush to hike policy rates over coming months

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USD/JPY bracing for a rebound

February 10, 2014 — Mitul Kotecha

In the post below I look at the arguments for JPY weakness in the weeks and months ahead.

A combination of elevated risk aversion and a narrowing US / Japan yield differential have been the major contributors to the strengthening in the JPY over January resulting in safe haven JPY demand and repatriation flows. The sensitivity of the JPY to both factors has been especially strong and it will require a reversal of one if not both of these to spur another wave of JPY selling.

Improving risk appetite required
If there is not a metamorphosis of the current bout of pressure into a full blown crisis as seems likely, risk appetite will improve and the upward pressure on the JPY will abate. Any improvement in risk appetite will however, be gradual and prone to volatility, especially in an environment of Fed tapering. It may therefore require more than simply improving risk appetite to weaken the JPY anew.

Japanese equity performance will be eyed
Of course associated with any improvement in risk appetite has to be a reversal of the recent negative performance of Japanese equities. Although Japanese equities will continue to be hostage to the fortunes of global risk sentiment, assuming that “Abenomics” continues to deliver results and growth in Japan continues to pick up (our forecast this year is 2% YoY GDP growth) further fallout in the Japanese equity market may be limited.

Flows will need to reverse
Over the past several weeks Japan has registered net inflows of capital in large part due to repatriation by Japanese investors. JPY has faced upward pressure from such inflows over recent weeks. Looking ahead assuming that risk appetite improves and US yields increase net capital outflows are expected to resume, which will put further downward pressure on the JPY.

Yield differentials will be particularly important
The extra dose of JPY pressure and important determinant of renewed weakness will be a re-widening of the US / Japan real yield differential. Eventually US bond yields will resume their ascent, driving the yield differential with Japan wider, and putting upward pressure on USD/JPY. The same argument will apply for EUR/JPY, albeit to a lesser degree.

Speculation positioning more balanced
The recent short covering rally has likely resulted in a market more evenly balanced in terms of positioning, providing a solid footing for the next leg lower in JPY. Indeed, compared to the three month average, JPY positioning has bounced back and is susceptible to a rebuilding of JPY shorts over coming weeks, driving the JPY lower.

Model points to renewed JPY weakness
Combining the factors above (except positioning) and adding in forecasts for US bond yields, risk aversion and conservative estimates for a recovery in Japanese equity markets over coming months, my quantitative model for USD/JPY highlights the prospects of a major rebound in the currency pair.

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USD/JPY biased higher within a tight range

January 28, 2014 — Mitul Kotecha

After hitting a low around 101.77 yesterday USD/JPY rebounded. USD/JPY short term range is seen at 101.62-103.58. Bias for more short term USD/JPY upside. The bounce in US 10 year Treasury yields overnight will give the USD some support versus JPY.

A combination of a sharp decline in US Treasury yields (narrowing the yield differential with Japan) and elevated risk aversion (my risk barometer has breached its upper band) had pushed the JPY higher.

The close to 30 bps drop in US 10 year yields since the start of the year looks excessive however, and assuming the Fed continues to taper at tomorrow’s FOMC meeting I see little reason for US bond yields to drop much further, suggesting more limited scope for JPY upside versus USD from current levels.

The only caveat is risk aversion. Given that emerging market tensions are unlikely to ease quickly there will be scope for sharp bouts of safe haven JPY buying as risk aversion intensifies.

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