Japan and UK in Focus

The foreign exchange market has turned quiet, but there are two developments to note.  First, Japanese traders, like their North American counterparts were reluctant to take the US dollar above the downtrend line drawn off the July and September highs.  It comes in just below the JPY100 level.  The greenback has been confined to a tight 25 tick range against the yen today.

Japan reported a slightly smaller decline than expected in the Corporate Goods Price Index, but the year-over-year rise increased to 2.5% from 2.%, supporting hopes that deflation has indeed been arrested, even if the threat appears to be increasing in the euro area (and Sweden).  On the other hand, core machinery orders disappointed, contracting 2.1% in September, about half again as much as the market expected.  Core machinery orders are seen as a proxy for capex and tomorrow Japan is reporting Q3 GDP, which is likely to show capital expenditures slowed; gaining around 0.8% after rising 1.3% in Q2.

This is in line with the overall moderation of Japanese growth that is expected.  After expanding by 0.9% in Q2, the consensus for Q3 is around 0.4%.  Housing and public investment are expected to be bright spots, and this seems to be (largely?) rebuilding and the first arrow of Abenomics, fiscal stimulus.  Despite this year's decline in the yen, exports may be a drag on growth, for the first time in a few quarters.  We have argued that observers often exaggerate the impact of a weaker currency on boosting exports.  The key often seems to be foreign demand.

The slowing of capex, however, illustrates the challenges of Abenomics.  A Bloomberg poll conducted at the end of last month found 25 of 34 economists expect the BOJ to increase its monetary stimulus in the first half of 2014.  However, the source of concern tends to be on the third arrow of Abenomics, the structural reforms.  

There are measures, either taking place already, such as the new NISA program of tax free savings (JPY1 mln a year for what is initially a 5 year program), or in the planning stage, (like IRA type of retirement savings vehicle) or being prepared,  ( like the new special strategic zones, similar to the special economic zones or free trade zones that other countries, including China, have experimented with, which may offer lower tax schedules and less regulated business environment).  

Japanese officials we spoke with have intimated that other measures will be forthcoming.  None in and of themselves may be considered very dramatic, offering only incremental payoffs, but cumulatively will be transformational, they say.  The combination of the doubling of the capital gains tax starting Jan 1 and the hike in the retail sales tax on April 1, from 5% to 8% may very well challenge the official optimism. 

The second noteworthy development today comes from the UK.  Following on the heels of a better than expected Oct employment report, the BOE's Quarterly Inflation Report brought forward the likelihood that the 7% unemployment threshold could be reached in Q3 2015, well sooner than it thought a few months ago.  The BOE also reduced its inflation forecasts and now sees CPI slowing to just below 2% by Q1 2015.    Its growth forecasts were unchanged.   While there is some speculation that the Federal Reserve may lower its unemployment threshold, Governor Carney rejected suggestions the BOE should. 

The net effect was to send sterling broadly higher.  Short-term UK interest rates, as reflected in the short-sterling futures, where implied rates rose and the curve steepened.  After trading at two-month lows yesterday and violating a neck line of the double top pattern we have been monitoring on an intra-day basis, has rallied more than a cent of lows set prior to the employment rights and briefly poked through the $1.60 level, before returning to the $!.5950 area.     UK gilts are also under pressure and the spread over US Treasuries and Germany bunds widening.  

The euro initially extend its recovery to test the 20-day moving average near GBP0.8460 and was turned back aggressively.  Since the employment data and BOE report, the euro has surrendered today's gains and retraced 50% (@ GBP0.8380) 50% of the advance off the test on GBP0.8300 last week. 

While Japanese and UK developments dominate today's focus, later we anticipate the EU to issue its report on excess imbalances.  Of course, the usual suspects will be reviewed.  We note that in last year's report, Spain failed 6 of the 11 indicators the EU employed.  We suspect a better report this year.  Most interesting, though may be what, if anything, is said about Germany's current account surplus.  It was not just the US Treasury's report that cited concern that Germany is failing to offset the austerity in the periphery and is thus forcing a deflationary situation and producing potentially disruptive imbalances.  The IMF echoed similar sentiments as did EC Commissioner Rehn, to some extent.

Elsewhere, we note that following the return to deflation in Sweden, seen in yesterday's CPI report, and follows weak industrial output figures, the finance minister appears to adding to the pressure on the central bank to cut rates.  Even though the  krona is trading at 17 month lows against the euro today, Fin Min Borg blamed the strong currency.  The central bank has been more concerned about the potential excesses in the housing market and the record high private debt and has denied the importance of the krona in setting policy.  That said, there has been a consistent minority (2 of 6) that have been arguing for a rate cut.  We suspect that the rate cut camp will move back into ascendancy with a rate cut possible next month or early Q1 14. 

There are no important economic reports from the US or Canada today.  Bernanke does speak at a town hall meeting (with teachers) and there will be a Q&A session, but takes place in the evening. 
Japan and UK in Focus Japan and UK in Focus Reviewed by Marc Chandler on November 13, 2013 Rating: 5
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