Euro and Sterling are Sold into Upticks, Yen Firms Further

The US dollar and yen remain firm. The ramifications of Brexit continue to weigh on sterling and the euro. After nearing $1.4050 yesterday, sterling could not move much above $1.4150 before sellers re-emerged. The euro, which came close to $1.10 yesterday, was sold into about half a cent bounce. It marginally extended yesterday's decline, slipping to almost $1.0990.

There is no fresh catalyst, but Germany's IFO survey did the single currency no favors. The assessment of the business climate fell for the third consecutive month (105.7 from 107.3). The current situation improved (112.9 vs. 112.5), but the expectations component deteriorated (98.8 vs. 102.3). Yesterday, the flash manufacturing PMI fell to 15-month lows.

Europe's largest economy has lost some momentum. It is materializing as Germany also faces a changing political climate. Merkel's public support has softened over the refugee issue, and three states hold elections next month that will be important tests for the Chancellor's political future.

Separately, details of Germany's Q4 GDP were released. They confirm that despite the weaker euro, and suggestions that is a beneficiary of the so-called currency wars, German net exports were a drag on growth for the second consecutive quarter. Not only was German growth (0.3% quarter-over-quarter fueled by domestic demand, the mix including a 1.5% rise in business investment and a 1% increase in government spending. This combination is precisely what Germany's critics have been advocating.

The Survation poll in the UK, conducted by telephone over the weekend, found 48% want to stay in the EU. A full third want to leave, and almost one in five are undecided. Nevertheless, the impact of a Brexit, on sterling (and the euro) is seen to be sufficiently grave as to offset the actual odds of it materializing.

Although we suspect the price action is exaggerated, but from a technical perspective, it does not seem like the move has exhausted itself. The $1.40 area is significant. Its failure to hold could see a move toward $1.37 as the next target. The euro support is seen near $1.0950.

The yen remains resilient. It did not weaken as much as the rally in the US stocks and increase in bond yields had suggested was likely. Today, the yen and Swiss franc are the strongest of the major currencies (advancing 0.8% and 0.4% respectively). Global equities are easing after yesterday's advance. Bond yields are mostly little changed, and oil prices are off about 2%.

BOJ Governor Kuroda's speech to parliament today was important. He confirmed a shift that seemed to have been signaled by the recent surprise rate cut decision. In effect, Kuroda acknowledged that increasing the monetary base was not sufficient to boost inflation expectations and inflation, which was the centerpiece of the QQE. Instead, Kuroda indicated that lower interest rate will be pursued to close the output gap, which in turn will lift inflation and inflation expectations.

If it is a question of emphasis, Kuroda seemed to be embracing more of the Keynesian approach than the monetarist approach. The problem, however, is that trend growth in Japan is too low. The BOJ estimates it to be around 0.5%. Despite the economy having contracted for two of the past three-quarters, full employment appears to have been achieved (though without upward pressure on wages).

Kuroda's comments also lend support to ideas that now that the negative interest rate threshold has been crossed, it may be used more frequently than the adjustments to the monetary base. Kuroda appears to be giving as much of a signal as possible to expect additional rate cuts. A move as early as next month cannot be ruled out.

The dollar has been pushed through the JPY112.00 level after trading near JPY113.40 yesterday. We have been concerned that from a technical perspective, there was scope for the greenback return to, and possibly through the low just below JPY111.00 on February 11. We have identified the JPY110.50 area as a near-term objective and recognize the significance of JPY110.

In his pre-G20 presentation, US Treasury Secretary Lew reiterated US position. Contrary to the spin of some news wires, he did not announce a new policy. The US Treasury's semi-annual report have not objected to the unorthodox monetary policies as a act of (currency) war.

Rather, the criticism has been what is seen as an over-reliance on monetary policy, without significant structural reforms or other attempts to bolster aggregate demand, especially from current account surplus countries. The US Treasury has also been critical of smaller countries, like South Korea and Taiwan for too frequent intervention and the lack of transparency. This criticism has also been levied against China.

The US concern is not over what China says. In fact, it seems as if the US can embrace much of what the PBOC says about the yuan. The issue is the gap between what China says and what China does. Simply because China is a one-party state, it does not mean the government is homogeneous. There are many different stakeholders, and the reform-minded PBOC is one among many, and its arguments do not always seem to carry the day.