Resignation of Japan’s Prime Minister Puts Yen Center Stage


The US dollar is little changed against most of the European currencies and within the dollar-bloc as a consolidative phase is emerging.  The yen is center stage today following the resignation of Japan’s prime minister.  The political uncertainty and calmer capital markets have seen the greenback extended its recovery against the yen to about 3% off the recent (May 20th) low near JPY89.  Resistance in the JPY92.00-JPY92.30 area is being flirted with just prior to the start of the North American session. Sterling is also a standout as its recent gains are extended.  Unwinding Prudential/AIA related positions/hedges and flows out the euro zone are the key talking points.  Since its recent low (May 20th) sterling has advanced about 3.8%.   In consolidative/risk-on phases, we think attractive tactical opportunities exist in the dollar-bloc.  We also like Sweden (though it is near the year’s highs against the euro), as the Riksbank is among the leading candidates for a rate hike in early H2. 

The greater stability in the foreign exchange market does not mean global equities are higher.  To the contrary, Asian and European equities are lower.  The MSCI Asian-Pacific Index shed 1.1%, weighed down by industrials and commodity sectors.   The Nikkei fell from the get-go and extending the losses following the political developments, but stabilized to close off 1.1%.   In contrast, the Shanghai market opened lower and recovered steadily to eke out a 0.1% rise.   India’s market is among the best performers today, led primarily by the out performance of its telecom sector, amid talk of foreign interest in a local mobile phone operator.   European bourse are nursing around a 1% decline near midday, paring back steeper initial losses.  Health care appears to be faring the best.  Oil, gas, utilities, and financials are dragging up the rear. 

Sovereign bond markets are generally quiet, but there are a few notes.  First, Italian and Spanish bonds are under performing, with 10-year yields rising 6-7 bp compared with 1 bp increase in Portugal.  Second, Thailand as expected left rates steady at 1.25%.  Third, Chinese money market rates continue to rise, with the 7-day repo rate rising to 3.28%, the highest since Oct 08, following the first increase in the one year bill rate in four months.  The PBOC has been draining liquidity and the large bank convertible bond sale appears to be exacerbating conditions.  The 12-month non-deliverable forward for the yuan continues to trend lower and is now near 0.7%. 

Currency Markets

Japan’s Prime Minister Hatoyama resigned.  There were such hopes for the DPJ, but the combination of party scandals and the controversy over the failure to carry out a campaign promise about moving the US Marine Corp base off of Okinawa ultimately proved overwhelming.  His resignation and the resignation of the DPJ Secretary General Ozawa, who was also the key strategist and powerbroker, leaves the DPJ seemingly rudderless ahead of two key events.  The government was working on a fiscal consolidation plan that was to be unveiled in the coming weeks.  This was the report that S&P recently identified as key to its rating decision after putting Japan on watch earlier this year. The weakened political environment makes bold action, which is needed, less likely.  And this in turn raises the prospects of a Japanese downgrade.  Note that earlier today S&P warned that Japanese regional banks face falling profitability.  The poor political climate is underscored that not only has Hatoyama not last a year as prime minister, but the previous three LDP prime ministers did not either.  The second key event is the upper house election, expected July 11th.  Half of the 242 seats are up for election.  The DPJ and their allies are likely to lose their majority, but will retain it in the more powerful lower house.    The DPJ will have a leadership contest at the end of the week.  Such a short time period would favor those that are already organized.  The favorite must be the outspoken Finance Minister Naoto Kan.

Several countries, including Brazil, Russia, India, Japan, and South Korea have all come out and said nice things about the euro.  As we have argued, reserve managers do not typically react to short run developments.  They often move, it seems, at glacial speeds, with due deliberation and caution.  In addition, there is truly little alternative.  Since the end of Bretton Woods, it appears that the world, or at least that part that reports the composition of its reserves, feels comfortable holdings 60-70% of the reserves in dollars 20-25% in European currencies (ECU, mark, and franc before the euro) and 10%+ in other currencies, including sterling and the yen.  Valuation swings would seem to account for the bulk of the volatility of reserves and their composition.  That said, it does appear that developing countries have generally speaking a lower share of dollar in reserves than the developed countries.  Central banks may not be reducing their euro holdings, suggesting that private investors accounted for the bulk of the divestment of European bonds in Q4 09 that has been reported as part of the ECB’s capital account report.  On the other hand, there are some news wires reporting that the Iranians may be an exception and have begun selling off some 45 bln euros.  The reports suggest they are buying dollars and gold.  It is difficult to verify these claims.

Separately, there are a few other developments in Europe to note.  There is some indication that the vote on Portugal’s recently announced austerity package may be delayed today, though there has been no official confirmation.  The final vote is expected on June 9th.  In Italy, news that the May state deficit was 8.1 bln euros vs. 7.95 bln euros last May could be a factor weighing on Italian bonds today.  However, Italian officials note that this figure includes a loan to Greece, without which there would have been some improvement.   Third, UK gilts have recovered initial losses following a successful 5-year gilt auction.  A total of GBP4.25 bln of a re-opened 2015 issue were sold.  The bid-cover was essentially the same as it was at the initial sale in March of 2.34.   There may have been some nervousness ahead of the auction after a German bund auction failed (not enough buyers) last week.   Separately, the UK reported better than expected construction PMI (strongest since Sept. 07) and mortgage approvals, but disappointing consumer credit figures.

Upcoming Economic Releases
Pending April US home sales at 10:00 EST/14:00 GMT are likely to have remained elevated due to tax incentive considerations.  This factor is expected to fade in the H2.  US auto sales will trickle in most of the day.  The consensus expects a small increase.  No Fed officials are slated to speak.   AS the weekend G20 meeting draws closer, more official jawboning is expected.

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