Friday's Drivers: Japan and IFO

Japan’s markets re-opened earlier today after yesterday’s holiday. Given the recovery of the yen in recent trading, the market was particularly sensitive to the threat of intervention.

After a quiet start to the Asian session two things happened around the same time. First, Reuters reported talk that the BOJ Governor was preparing to resign. This is seen as yen negative on the grounds that Shirakawa’s replacement could only be more aggressive in terms of intervention (although it is not the BOJ’s call) and other stimulative measures.

Second, a couple of Japanese banks were thought to be significant dollar buyers and they immediately suspected of operating for the BOJ. Japanese officials refused to comment, unlike last week’s operation when they quickly confirmed it.

This is a good example of “strategic ambiguity” as a tactic. Market participants cannot be sure either way and at the same time, by keeping a lower profile, may be less objectionable to other countries. In some ways, it might not really matter, though on balance our Asian contacts suspect intervention did not really take place.

Intervention or not, the more important consideration is the broad move against the US dollar. In addition, to the extent the BOJ intervention has an impact, the biggest bang comes from the first operation and then it seems it would quickly reach the point of diminishing returns. What appears to be record intervention last week drove the dollar 3 yen higher. Today’s intervention (real or imagined was worth about one yen. The Shirakawa rumors have been denied.

The next key event in Japan is the Tankan survey out on Oct 1 and is expected to show a small improvement for large manufacturer sentiment, but cautious capex plans.

The euro extended yesterday’s pullback in Asia. Stops triggered on the break of $1.3300 carried the euro down to $1.3286 before bids were found. It was trading listlessly just above $1.33 before the IFO survey. News of the unexpected rise saw the euro surge above $1.3400 and approach the multi-month high set Wednesday near $1.3440.

The main market focus of the IFO survey was the business climate reading and that rose to 106.8, a new three-year high. The market had expected a small decline from the 106.7 reading in August. The assessment of current conditions is where the strength of the survey can be found. However, futures expectations continued to deteriorate. The risk is just as the German (euro zone) economy moderates from the heady Q2 pace it gets hit with the fiscal drag.

The euro has proven quite resilient to the record widening of Irish and Portuguese premiums over Germany and record credit-default prices. The pressure on Portugal is stemming from political wrangling over the budget. In Ireland, the pressure is emanating from concern about what happens when the government guarantees on subordinated debt sold by Irish banks ends next week.

The resilience of the euro may be partly explained by the increased confidence among many market participants that the Federal Reserve will take additional measures in a few weeks. Given that the bar to Fed action seems relatively low, investors are sensitive to marginal developments. In this context yesterday’s news that the US Congress is unlikely to vote on the tax cut extension bill. This has negative implications of investment plan and tax withholding. The election is a wild card and even if the measures are passed after the election, it may impact some firms spending plans and see GDP forecasts trimmed further. US developments are outweighing the mixed news stream from Europe.