Yen Weakness Drives FX Market

The main driver in the foreign exchange market as the week winds down is a new sell-off in the Japanese yen, ostensibly recorded on the back of LDP leader and expected new prime minister in a little more than two weeks time.  Although Abe appears to have soften some of his aggressive rhetoric regarding the BOJ ostensible independence, he did reiterate his desire for it to buy foreign bonds. 

This helped send the dollar to new highs for the week against the yen near JPY82.75.  Market talks suggest some optionality in front of last week's high near JPY82.85 may be restraining the greenback a bit here.  Meanwhile, the yen's weakness and the euro's recovery from the decline seen in NY yesterday in response to headlines about the lack of progress on the fiscal cliff talks in the US. kept the cross rates in play.  Cross rates adjustments helped lift the euro and sterling to new multi-week highs against the dollar. 

The move started in Asia and Europe largely consolidated the price action, correcting the over-extended intra-day technical indicators, clearing the way for another attempt on the euro and sterling's upside in North America today.  

Japanese data was mixed.  The fact that deflation is still evident would seem to strengthen the case for more action by the BOJ.  Core (which excludes fresh food in Japan) Oct CPI was flat, after a 0.1% decline year-over-year in September.  While this snapped a five month decline, excluding food and energy, consumer prices fell 0.5% compared with -0.6% in Sept.  Tokyo core Nov CPI, a good lead indicator fell 0.5% year-over-year compared with -0.4% in Sept.  Excluding food and energy, Tokyo prices fell 0.9% year-over-year.  Separately, unemployment was unchanged at 4.2%, though the job-to-applicant ratio fell for the second consecutive month.

There were two pleasant surprises in Japan's data.  First, industrial production rose 1.8% in October.  The consensus had forecast a 2.2% decline after the 4.1% fall in September.  This is the first increase in four months and producers are optimistic for Nov output.  Second, household spending rose 0.6% in October.  The consensus called for a 0.4% fall.  

The better household consumption contrasts with the German and French figures released today.  German retail sales fell a whopping 2.8% in Oct.  The consensus was for a 0.2% decline.  This follows a 0.5% rise in September.  French household consumption fell 0.2% in October.   This data, coupled with euro area unemployment ticking up to a new high of 11.7% in October reinforces expectations that the euro area economy is still contracting.  

The lack of aggregate demand in the euro area did not go unnoticed by the US Treasury, whose report earlier this week noted that while the Chinese trade current account surplus has been dramatically reduced (from over 10% in 2007 to 2.6% recently), the German current account surplus of 6.3% of GDP remains a significant imbalance.  The Dutch surplus is even bigger at 9.5% of GDP.  Switzerland's current account surplus stands near 13% of GDP.  Neither the Dutch nor the Swiss surpluses receive the criticism that German does because it is the fourth largest economy in the world. 

The European court yesterday ruled that the ECB did not make public details about how Greece hid its debt using derivative.  Yet Greece remains very much in the news today.  We anticipate the German parliament, to approve the new deal.  However, problems are already surfacing.  Much of it hinges on a successful bond buy back, which sounds sufficiently benign until one looks more closely at it.  

After taking a 53.5% haircut several months ago, the bond-buy back amounts to another steep haircut on those newly issued bonds.  Some hedge funds who bought the deeply distressed issues might be able to profit, but the Greek banks are balking.  This was made clear in a meeting yesterday between the Greek banking association and Greek Finance Minister Stournaras.  

The four largest banks hold about 17 bln euros of government bonds.  Stournaras claims it is the Greek banks "patriotic duty" to participate in this voluntary operation.  The banks push back.  They argue such a material impact on their balance sheets require shareholder support and more liberal bank recap rules.  Recall the IMF will not approve of a tranche payment to Greece unless the bond buy back is successful.