Yen Drops, Lifts Other Currencies

The weakness of the yen is the main development in the foreign exchange market. The dollar resurfaced about JPY99 for the first time this week. The ostensibly driver is the realization that, as we anticipated, Japan's aggressive monetary stance has not sparked much of a reaction from the G20. The leaked draft statement appears to give it a pass. Importantly the yen selling took place in Asia. It helped lift the other major currencies and many of the emerging market currencies. Gold is recovering and has now the week's low set on Tuesday. 

These corrective gains are coming amid a generalized "risk-on" mode ahead of the weekend. Global stocks have rallied. The MSCI Asia-Pacific Index is up about 0.5%. Chinese markets led the way. With a 2.1% gain, the Shanghai Composite reversed this week;s loss amid reports suggesting China is lobbying to have its A-shares included into the MSCI Emerging Market Index, which of course, would likely force some more buying by foreign funds. 

European bourses are higher as well and today's gains are paring this week's losses.  Spain and Italian markets are leading the way up over 1%, while the Dow Jones Stoxx 600 is up a little more than 0.5% near midday in London, led by financials, telecoms and basic materials.  Technology is under-performing and may be linked to the some disappointing earnings in the US (e.g. IBM).  The same general "risk-on" is seen in the bond markets with Italian and Spanish bonds firm, while core bonds are a bit lower. 

Outside of the growing realization that the BOJ Q-squared (qualitative and quantitative easing) is not objectionable in principle. new from Japan has been light.  Abe is pressing for companies to hike wages, but the employers association is reluctant to get behind it.  Some companies, especially in the auto sector, have raised bonuses, but one-off payments may not be sufficient to boost inflation expectations.  

Japanese life insurers are beginning to announce their investment plans for the new fiscal .  The head of the industry association indicated that its members are indeed likely to shift more funds into foreign bonds.  However, he warned that when JGB yields begin rising, repatriation may ensue.  Remember, typically Japanese life insurers and pension funds run relatively high hedge ratios, so the demand for foreign bonds is not the same as demand for foreign currency.  60-80% of the foreign currency risk is hedged.   Along side the new incremental buying of foreign bonds, some may adjust their hedge ratios. 

The Chinese yuan is posting its biggest weekly gain in six months.  The deputy governor of PBOC indicated  near mid-week in the run-up to the G20/IMF meetings in Washington that the 1% dollar-yuan band may be increased shortly.  The last widening of the band took place April 16 last year and so some pundits are focusing on the anniversary as a key date.  At least one investment house says that the move could take place as early as this weekend.  

We are a bit skeptical.  We do not put much emphasis in the anniversary, as it does not appear to be part of China's modus operandi.  Nor do we put much credence into ideas China would move during or just after  G20/IMF meeting.  It is also not part of its modus operandi, perhaps because it looks like bowing to international pressure.  In addition, we note that Chinese policy makers are far from a homogeneous group.  The PBOC has typically pushed for faster liberalization than the central committee has often supported. 

The news stream from Europe is light.  The Italian presidential election is being watched closely.  Recall that the 3rd ballot today still requires a 2/3 majority to win.  After this a simple majority will do.   The center-left's Bersani has sought to delay a fourth ballot today to re-group and strategize, but the center-right seems opposed.  

The center-left has a majority, but there are two mitigating factors.  First, the split between Bersani and Renzi may weaken its position.  Second, if the center-left pushes through its own candidate, without compromising, it may be more difficult to resolve the larger issue of putting together a new government.  Ironically then, it is possible that a center-left victory for president could force the early election scenario (as early as June).   

The only data in North America today comes in the form of Canada's CPI.  The headline year-over-year rate may slip to 1.1% while the core remains steady at 1.4%.  Earlier this week, the Bank of Canada downgraded its growth forecast and continued to push out when the economy will be at full capacity into 2015 from 2014.  The Canadian dollar is off about 1% this week and is trading within yesterday's range.  The US dollar may find initial support in the CAD1.0200-20 ahead of the week.