Yen and Dollar-Bloc Sink, while Sterling Ticks Up

The run on the yen continues.  The US dollar and euro are at new multi-year highs against the yen.  The BOJ confirmed its JPY80 trillion monetary base target unexpectedly adopted at the end of last month.  Last month's seemingly last minute decision was based on a very un-Japanese 5-4 vote.  Today, three of the dissents accepted the fait accompli; one did not (Kiuch).  

The dollar is approaching resistance near JPY118, but many players feel emboldened by recent developments (and momentum) and are looking for JPY120 in the coming weeks. Despite the talk of "currency wars" and "race to the bottom" there is little official push-back.  In late-September and early-October, it seemed that some Japanese officials played down the benefits of a weaker yen.  We suggested at the time that one of the reasons for the seeming ambivalence was to indicate to the US and others in the G20 that the yen's depreciation was the result of market forces and not officials pushing it, as the ECB was pushing the euro.  

With the unexpected contraction in Q3 GDP, there is much talk about the failure of Abenomics. We demur, and this is an important interpretative point for investors.  If one thinks Abenomics failed, and that next month's election will result in a new mandate for Abe, then one would have a very negative outlook for the world's third largest economy.  Instead, if one recognizes Abenomics as aggressive monetary and fiscal initiatives, then the sales tax increase was a deviation from Abenomics.  The postponement of next year's planned increase, the supplemental budget was still expected, and the BOJ's stepped up monetary efforts suggests Abenomics is getting back on track.  In the five quarters before the sales tax hike, which  was approved on a bipartisan basis by the previous DPJ government, Japan's economy averaged quarterly growth (at an annualized pace) of 3.25%.  

It may be premature to say that the deflation dragon has been slayed, but even with the contraction in Q3 GDP, Japanese inflation, adjusted for the sales tax increase, is higher than most European countries.  That said, we have been critical, like others, that the Third Arrow of Abenomics, structural reforms have been more elusive than desired.   Yet structural reforms were about boosting Japanese growth potential and increasing returns not about short-run growth.  

Earlier this week, the Reserve Bank of Australia seemed to suggest that the capital flows out of Japan might help explain why the Australian dollar is trading rich to fundamentals.  That is not the case today.  Indeed the Australian dollar is down nearly two cents since Monday's high near $0.8800.  There are two triggers that participants are citing.  The first is the drop in iron-ore prices to new five-year lows.  We would not emphasize this because 1) the new free-trade agreement with China will likely help Australian iron ore exporters, 2) capital flows are a larger and more important driver for the Australian dollar than the flow of goods.  

The second is RBA Governor Steven intimation that interest rates are on hold for an extended period--a couple of years.  The OIS market reflects expectations for no hike until at least October 2016. Interest rates on 2-3 year government paper are essentially at the 2.5% cash rate.  

That said, we accept that the New Zealand dollar is more sensitive to trade flows.  The Kiwi capital market is not as important for global investors, and it is not a reserve currency as is the Aussie.  News of the latest drop in milk prices pulled the rug from underneath the New Zealand dollar yesterday, which appeared to have been stalling near $0.8000 in any event, and there has been additional follow through selling today.  

One of this week’s surprises continued today.  The Hong Kong-Shanghai equity link is not being used as much as expected.  The launch on Monday saw the entire quota of Shanghai share bought or around CNY13 bln.  Yesterday, the purchases fell to CNY4.8bln and today CNY2.6 bln.  We are reluctant to read too much into it, and note that there was much anticipation.  This anticipation had helped lift the Shanghai Composite to a three-year high exactly a week ago.  In addition, there are some technical issues that still appear to need working out, as the need to deliver securities before sell orders are placed. 

The main news from Europe was the BOE minutes.  After last week's dovish Quarterly Inflation Report and subsequent comments, the market was anticipated this to be reflected in the minutes.  In fact, the minutes seemed to be somewhat more balanced.  Moreover, Weale and McCafferty persisted with their dissents.  These dissents are unlike the dissents at the Federal Reserve, where some officials have object to this or that phrase relating to forward guidance.  The dissents on the MPC favor immediate rate hikes.   The minutes have helped underpin sterling, which, up 0.35% on the day, is the strongest of the major currencies.  

The US reports October housing starts and permits (little change, less than 1%, is expected), but the real interest lies with the FOMC minutes.  Given that the FOMC statement was a bit more hawkish than many expected, with an upgrade in the assessment of the labor market, many observers are looking for this tone to be reflected in the minutes. 

We are less sanguine.  The FOMC statement is the clearest indication of the views of the Fed’s leadership, which drives policy.  The dot-plots and the FOMC minutes contain a high noise-to-signal ratio.  The importance of the FOMC minutes for investors is to appreciate the topics discussed from a high level and the some broad outlines of the evolution of the Fed’ thinking.   Ironically, since the statement was seen as hawkish, and QE ended, we suspect the doves (one dissented) may have gotten more “air-time”.     That said, we caution against attaching too much significance to the market’s knee-jerk reaction. 

Lastly, we note that the TIC data was reported yesterday at the close of trading.  To the extent market participants use this report; the focus is on the assets that foreign investors are buying from the US.  Given the shape of the US yield curve and the strength of the dollar in September, it is not surprising that investors favored long-term US assets.  Indeed, off-shore investors bought $164 bln long-term US securities.  However, they sold $210 bln of short-term assets.  This resulted in a net outflow of $55.6 bln.  The August series was revised to $44.8 bln net inflow rather than $74.5 bln. 

This is largely uncontroversial.  What is less appreciated is what American investors were doing in September as the dollar rallied across the board.  American was bought a record amount of foreign bonds and stocks.  Specifically, Americans bought $30 bln of foreign equities.  Before 2000, rarely did thye buy even $10 bln of foreign shares in a month.  The previous high was in October 2008 when Americans bought $21.4 bln of foreign stocks.  Americans bought $40 bln of foreign bonds in September.  Only twice before did they buy even $30 bln of foreign bonds in a month.