Like stones in water
The Nikkei sinks lower yet
What now Abe-san?
Japan continues to lead the market, at least with regards to generating stories about why volatility is increasing. Another awful night for the Nikkei, down 6.4%, has led to a more than 1% rally in the yen, an increase in yen implied volatility to its highest point in more than 2 years, and a general increase in fear that the world’s central banks may have run out of tools to manage markets as they see fit. Perhaps it is a good thing if they stop trying to micromanage the global economy and focus only on managing inflation, but I doubt any central banker in existence can do that.
So we have a combination of two key factors driving markets right now; first the Fed and the question of whether they will begin to ‘taper’ their purchases in the near future; and second, Japan and whether PM Abe has the ability to capture control of the Upper House of the Diet and use that increase in political strength to launch the stimulus and efficiency drive he has discussed. Right now the market is basically clueless on both subjects, although I would contend that most pundits would say both things will happen, eventually. But in life, timing is everything, and just what the timing of these actions will be is the wildcard. Think about it, we are discussing the Fed reducing its stimulus at the same time the World Bank (along with every other global institution) is cutting its forecast for global growth. Last night they lopped another 0.2% from their 2013 forecast, down to 2.2%. We have seen reductions in forecasts for Chinese growth, Eurozone growth and US growth. Emerging market economies have seen substantial outflows from both their bond and equity markets and EMG currencies have fallen sharply over the past three weeks. Is this really the best time for Berdudlen to cut back?
And what about Japan? Equities there have fallen more than 20% from their recent peak on May 23, which many define as a bear market. Of course it is a bit ridiculous in my mind to say that a 3-week correction to a 6-month trend is actually a bear market. It is a correction, one that is both necessary and likely healthy for the longer term prospects for Japanese stocks. But it is painful. And you must remember that the FX market is notorious for its extremely short term thinking. So despite the prospect of things improving significantly after the election on July 21, FX traders are in full-scale panic mode.
Let’s recap currency movements vs. the USD since that Nikkei peak:
Emerging market currencies have suffered, but more against the yen than the dollar. This remains very much a yen story for now. The latest data shows that Japanese money managers have been liquidating both foreign bond and equity positions, down a combined $6.4 billion last week. One of the key drivers in my view of a weaker yen was the likely outflow of Japanese investment. It can be no surprise that the reduction in that outflow is resulting in a stronger yen. But the question you need to ask is, will this continue? I firmly believe that while the current market volatility can be harrowing, the underlying story remains one where Abe and Kuroda will push their agenda more aggressively within months, and that the yen will suffer at that time. So yen receivables hedgers, don’t miss this opportunity. The yen is not going back to 88 or even 90, it will find a base in the near future.
As to emerging markets, I continue to believe that current levels offer hedging opportunities for payables hedgers.
Later this morning we will see US Retail Sales (exp 0.4%, 0.3% ex autos) and Initial Claims (346K). Are they likely to move the FX markets? I don’t think the market is paying much attention to this data right now. For this session, equities will be the key driver (SPU’s are down 6 points as I write), but really, I expect to hear some comments from Fed officials soon, as they cannot seem to allow markets to simply trade without imparting their ‘wisdom’. And we all know that if the stock market rallies irrationally, that is the benefit of Fed wisdom, but if it falls, it is evil short sellers and speculators profiting at your expense!