Yen Soars, while Dollar Stabilizes

Japanese markets seem to be driving the developments in the capital markets. The powerful short squeeze in the yen continues and the Nikkei's 6.3% slide is serving to drag down global equity prices.

The dollar was pushed through the JPY95 to hit a low near JPY93.80. These losses mean that the greenback has surrendered 38.2% of its appreciation recorded since Abe's rise was anticipated in mid-Nov 2012. That level is found near JPY94.35, around where it is trading as the North American session opens. There is market talk of optionality and stops struck near JPY93.50. Below here, participants talk about the lows from early April near JPY92.70 and the 50% retracement objective near JPY91.50.

We had thought there was a reasonable chance that the nearly 10-yen pullback in the dollar to JPY95 was sufficient and that this may have marked the lower end of a new range for the dollar. Although we have been skeptical of what some had heralded as the trade of the century--selling yen--and had a JPY95 quarter end forecast, we under-estimated the power of the short-squeeze and dramatic rise in volatility.

The Nikkei tanked 6.3% to its lowest level since BOJ Governor Kuroda unveiled the aggressive monetary stimulus in early April. The Nikkei moved within spitting distance of a 50% retracement of its Abe-inspired gains (12281 vs today's low near 12416). The important note here is that foreign investors have, at least through last week, not been shaken. As noted earlier, foreign investors, according to the latest MOF data were net buyers of Japanese shares in the week ending last Friday.

Some accounts appear to have lightened up on their short yen hedges and this may have helped them sustain the positions.  Since peaking in late May, for example, the Nikkei is off about 22% while the yen has risen by almost 10%.  Other investors appear content to weather the near-term storm on ideas that there has been a significant regime change in Japan and the period of deeply under-weighting Japanese shares, relative to benchmarks, may have ended, even if Japanese officials struggle with the implementation of their economic strategy.  

The poor price action in the S&P 500 coupled with the deep slide in the Nikkei was too much for Asian and European bourses.  Chinese markets, which returned after the public holiday in the first half of the week saw its shares slump 2.75%, led by basic materials and utilities.  With a 3% move down today, the MSCI Asia-Pacific Index set new lows for the year today.  

European bourses are under pressure.  The Dow Jones Stoxx 600 is off about 1%, recovering from steeper losses earlier.  Telecom, industrials, and consumer goods and services are the weakest sectors.   The S&P 500 is set to open lower, but the US reports retail sales and weekly jobless claims before the start.   The potential bullish chart formation we noted Tuesday has not panned out.  The market is now watching the 1598-1600 level.  A break of this would be like the groundhog seeing its shadow, signaling deeper losses.  

The euro's gains were initially extended to $1.3390.  However, it has since reversed lower and is back below the 61.8% retracement objective of this year's decline that is found near $1.3340.   Initial support is seen near $1.3300 now and a break of $1.3260-80 would undermine the technical tone.  

Sterling reached a 10-week high yesterday and could not really better it today.  Although sentiment has turned more constructive, following the recent economic data that pointed to some strengthening of economic activity, it has retraced a smaller part of this year's losses than the euro.  The $1.56 level corresponds to a 50% retracement.  The 61.8% retracement, which the euro has surpassed, comes in near $1.5790 for sterling.  

The Australian dollar initially rallied on the headline news of stronger than expected job gains.  However, as the data was scrutinized, it did not appear as strong as the optics suggested and the Aussie reversed to make new lows on the session and only then launched a more proper rally that lifted it a cent from yesterday's NY close.  

The headline rise of 1.1k jobs compared with expectations for a 10k decline after strong April gains.  Yet, full time positions actually fell by 5.5k and the April series was revised down 5k to 45k.  Net-net the real signal was in line with expectations.  The recovery of the Aussie is more a reflection of the deeply over-sold market and a downgrading of expectations that the RBA would cut rates in early July. We do expect another 25 bp rate cut in Q3, but have thought July was pushing it.   August is our preferred window, but recognize that the election may not pose much of an obstacle to a September rate cut if no move in August.  

New Zealand's central bank met and left rates on hold.  The New Zealand dollar has fallen almost 10% from end of April through the lows set earlier this week.  This has not been sufficient to appease the central bank, which continues to press its case that it remains significantly over-valued.  It has not built on yesterday's recovery as the Aussie has, but a move above $0.8040 would suggest a near-term bottom is in place, RBNZ wishes not withstanding.  

The data highlight of the North American session will be the retail sales report and the weekly jobless claims.  The US consumer has been fairly resilient in the face of weak wage growth and the end of the payroll savings tax holiday.  That said, there appears to be downside risks to the consensus 0.4% increase on the headline rate.  Weekly initial jobless claims are expected to be flattish, near cyclical lows.  

Ideas that the Fed could taper its asset purchases as early as next week appear to be fading, but the new forecasts will be scrutinized to see tells that the Fed is anticipating a quickening of the pace of recovery, which would in turn strengthen ideas of a tapering in September.  We continue to see the near record low core PCE deflator, and other signs that price pressures are in check, as giving the Fed more time to run its monetary experiment.  Talk of tapering has stolen some thunder from its critics who have warned about the mis-pricing of risk and bubbles in other asset markets.