Yen Advances Mostly on Treasury Rally

Most of the major currencies are little changed against the dollar today. The yen is the main exception. The greenback appears poised to finished the week below the 200-day moving average against the yen for the first time since late 2012 (~JPY101.70).

The main impetus does not appear to be coming from Japan but from the drop in US Treasury yields following the unexpectedly large fall in US Q1 GDP revisions and softer than expected household consumption data. The US 10 year yield is off 11 bp this week, which is the largest decline among the major bond markets. It has brought the yield back below the downtrend line drawn off January and April highs.

Japanese data were a mixed bag. With the help of the sales tax and increase in utility prices, Japan's core inflation, which excludes fresh food, rose 3.4% above a year ago, the fastest clip in more than three decades. However, when the sales tax is excluded, which the BOJ's 2% target is based on, inflation actually eased to 1.4% from 1.5%. BOJ Kuroda warned investors recently that price pressures are likely to ease toward 1% in the coming months before resuming their climb toward the target.

Most of the increase in Japanese inflation can be accounted for the decline in the yen, which has stopped. Moreover, the fact that wages are lagging behind inflation means that the household continues to be squeezed in Japan. Not only have real wages fallen, but the higher inflation is eating away at returns to savings, and now the household has to pay more good goods due to the tax. The result is that overall household spending collapsed. The 8.0% decline in May (year-over-year) was more than three times worse than expected and was the largest decline since the national tragedy in March 2011. Moreover, this, despite the modest tightening in the labor market (3.5% unemployment from 3.6% and an increase in the job to applicant ratio.

The yen's strength also is coming while Japanese investors have also stepped up their buying of foreign bonds. The currency also took a toll on the equity market where the Nikkei has snapped a six week advancing streak. It fell 1.6% this week.

The euro itself is little changed against the dollar, making the losses of the euro-yen cross a function of the yen's move. After falling below the 200-day average earlier this month, the euro has tried in vain to resurfaces above it, but has been blocked. Now it is testing JPY138, just above the lows for the month near JPY137.70.

Euro zone new includes a somewhat softer Sentix confidence data and disappointing Spanish flash EU harmonized CPI (flat vs. expectations of 0.1% year-over-year from 0.2% in May). The German state CPI readings seem consistent with a pan-German reading in line with expectations for a small tick up to 0.7% from 0.6% (which will be released shortly).

UK data showed the year-over-year pace of growth in Q1 revised slight to 3.0% from 3.1%, but there was an important revision below the surface. Investment was revised to 5% (from 2.7%) quarter-over-quarter for a 10.6% year-over-year advance (vs. 8.7% in Q4 13). This has direct bearing on the debate over slack in the UK economy. It would argue in favor of more rather than less. Separately, the external deficit in Q1 current account deficit came in at GBP18.5 bln, down from GBP23.5 bln in Q4 13.

Sterling could not sustain the push above $1.7040, but the market does not appear to have given up and another run at it looks likely today or early next week. Buying on dips still seems the preferred strategy against both the dollar and euro.

Meanwhile, oil prices are set to finish the week about 1% lower. The Iraqi government success in pushing back against the insurgency coupled with increased shipments by OPEC (excluding Angola and Ecuador) appear to be doing the trick. Libyan output also increased. Next week the Iraqi parliament is expected to meet begin planning for a new, ideally more inclusive, government.

The North American calendar is light, with only the University of Michigan’s consumer confidence and Canada’s industrial and raw material price indices to distract investors from the weekend and the World Cup. There may be some headline risk from the EU Summit, where fiscal reviews and the appointment, presumably of Juncker as EC President are the main issues.