Adjustment Ahead of the Weekend, Yen Bounces

Corrective forces are taking hold in the foreign exchange market. It appears to have begun with Tokyo's reluctance to push the dollar through JPY100; frustrating the yen bears and spurring some profit-taking. If the short leg is being covered, the long-leg of the trades, like euro, sterling, Australian dollars and emerging market currencies are being liquidated. 

Talk of Middle East demand for euros was offset by this liquidation in the European morning that pushed the euro through yesterday's lows. Intra-day technical studies are over-extended, but chart support is not seen until $1.2980-$1.3000. That the heavy tone in the euro persisted despite news that February euro area industrial production rose 0.4%, twice the consensus, is consistent with the idea that position adjusting rather than fundamental developments are behind today's price action.

Many observers had been surprised to learn yesterday that far from being large net buyers of foreign bonds in the immediate aftermath of the BOJ's new initiative, Japanese investors were net sellers of JPY1.145 trillion of non-yen bonds last week, the most in nearly a year. We note that of the 14 weeks of MOF data for this year, Japanese investors have been net sellers of foreign bonds in all but three weeks.

That the selling is on a net basis, still allows for some gross buying. The Investment Trust Association reports that in the Jan-Feb period Japanese investors increased their purchases of bonds of Mexico (+34% to JPY216 bln), Turkey (+28% to JPY127 bln), South Africa (+44% to JPY100.2 bln), Thailand (+17% to JPY22.6 bln) and Philippines(+5.9% to 19 bln). 

Our point is two-fold. First, that Japanese have net sellers of foreign bonds is significant, but says nothing about any particular bilateral flow. This list of what Japanese investors have bought earlier this year is not meant to be exhaustive, but suggestive. The second point, though, is the relative small size of these flows. All told here it is JPY483 bln--about $5 bln--over a two month period.

The MOF flow data coupled with a strong impression in the market that Japanese accounts have not been pushing dollar-yen higher, and the failure of Tokyo to push the greenback through the JPY100 level is spurring some profit-taking. Today is the first day since early last week that the dollar has fallen through the previous day's low against the yen. There is talk of JPY99 strikes expiring today. This may deter the dollar from moving too far away from there.

The sell-off in Japanese government bonds this week has also been a significant surprise.  The BOJ will be doubling its purchases and absorbing nearly 3/4 of the new supply and the 10-year yield rose almost 10 bp this week.  The 30-year rose 26 bp.  The 10-year spread between US Treasuries and JGBs has narrowed 9 bp today and at 114 bp is the narrowest since late January.  News that the BOJ is considering raising its FY2014 inflation forecast to 1.5% from 0.9% at its next forecast update (April 26), is being cited by some as the key behind the JGB sell-off today.  However, it is clear that such a forecast would be meant as a signaling device of the BOJ's resolve. 

In some ways, to the extent the backing up of Japanese interest rates are a function of an increased inflation premium, the Abe and Kuroda cannot be too displeased, though the increased volatility is undesirable.  Despite the recovery in the yen and sell-off in JGBs, the equity market fared well, only declining 0.5%, and holding on to a 5% advance this week, the best performance in the major markets. 

The European finance ministers meet today and over the weekend.  There is much on their plates.  A Cyprus memorandum of understanding is still being negotiated, as is the next tranche of aid to Greece.  A decision to extend the maturities of EFSF/ESM loans to Portugal and Ireland is likely.  Portugal's judicial decision that bans some of the government austerity measures is causing some strains, but 10-year yields have fallen 7 bp this week, outperforming Spain (-3 bp) and Italy (+2 bp) this week.  

Meanwhile,  Italy's presidential commissions are expected to report later today that may serve as the basis for a new government.  Voting for the next Italian president is due to being next week.  Of note, former Prime Minister Amato, who had in the early 1990s, implemented the tax on all savings, is in the running to replace Napolitano whose term expires May 15.  

Lastly, we note that Berlusconi continues to moderate his strident tone and now says he can support a center-left president and will not seek amnesty (see statute of limitations?).   All this, by means of noting that Italy's political situation appears to be slowly improving and that the economic fallout has been marginal as Italian bond yields have returned to pre-election levels. 

The US reports retail sales (previewed yesterday), and the risk on the headline measures is to the downside of the flat consensus forecast.  Headline producer prices are expected to be soft, with the core steady at 1.7%.  Business inventories may attract economist attention as inventories are seen as a big part of the stronger growth in Q1.