Yen Drops Back After Japan Comments on Currency; IFO Ahead

From The BBH Currency Strategy Team.

Highlights
Though concerns about economic growth prospects in major economies are still dominating financial markets after the poor US data yesterday, verbal intervention from Japan’s Finance Minister Noda, Prime Minister Kan, and then FM Noda again finally saw the yen retreat from multi-year highs against the dollar and euro. USD/JPY climbed above JPY84 to an overnight high of JPY84.50, with resistance at JPY84.58. EUR/JPY surged to almost JPY107, before slipping to trade in the JPY106.50s. To reinforce the growth concerns, Japanese exports slowed for the fifth straight month. EUR/USD initially slipped back after Ireland’s long-term rating was cut a notch by S&P, before climbing above $1.2650. Germany releases the IFO index of business confidence this morning which is expected to show a first decline in three months. The Indian central bank’s annual report put inflation as its chief fear, suggesting rate hikes to come.  Most of the majors gained ground against the yen, but also against the greenback. EM currencies were split with losses for KRW (after consumer confidence fell), TWD, HUF and RUB, and gains for PHP, ZAR, MXN and TRY.

Asian stocks dropped back as concerns about global growth were underlined by poor US housing data yesterday, and evidence from Japan of slowing exports. The MSCI Asia Pacific index fell 1.7%, leaving it more than 10% down from its year high in April. Japan’s Nikkei declined 1.7%, the biggest loss in the region, and the index’s fourth straight decline. There were losses for benchmarks across Asia. Futures on both European and US markets are trading lower.

Bonds climbed in Japan but were mixed in Europe and the US. Japan’s benchmark 10-year yield slipped 2 basis points to 0.895% as poor data also combined with renewed speculation of further monetary easing measures from the Bank of Japan. Germany’s 10-year bund yield was steady at 2.18%, after dropping 9bps yesterday. The spread from benchmark German debt to similar maturity debt from Ireland rose 13bps to 317bps following Ireland’s downgrade. US Treasuries were steady, with the 10- and 30-year yields at .485% and 2.5% respectively. The 10-year dropped 11bps after yesterday’s US data.

Currency Markets
The yen sank back from a 15-year high against the greenback and near a nine-year high vs the euro as the Japanese authorities fanned speculation about possible intervention measures. Finance Minister Yoshihiko Noda said today that the government would consider ‘appropriate action’ on the currency, and that movements had been ‘one-sided.’ Late yesterday saw verbal interventions on the yen from both Noda and Prime Minister Naoto Kan, who said ‘steep currency gains are undesirable,’ initially to no effect whatsoever.  Their stance has changed noticeably from earlier in the week when they were at pains to point out that PM Kan and Bank of Japan’s Shirakawa hadn’t even discussed the possibility of intervention. As we’ve written before however, any BOJ intervention would likely be unilateral and thus ineffective. A parallel can be drawn with the Swiss National Bank, whose unilateral interventions to weaken CHF this past year may have slowed the move but did not reverse it.  It was only when market sentiment improved in July that EUR/CHF staged a strong bounce. Japan had a further reminder of the tough economic environment, when figures showed export growth slowed for the fifth straight month in July. Exports rose 23.5% from a year ago, down from June’s 27.7% growth rate.

The focus on economic difficulties in Europe will resume today with the release of the German IFO index of business confidence. The overall index is expected to drop to 105.7 in August from 106.2. The euro has rebounded from its earlier drop to a low of 1.2588 which remains a key support. It’s trading around the 1.2650 mark with some support at 1.2620-30. It would be the first decline in the main index for three months, and would again reinforce the sense that growth in Europe’s largest economy peaked in the second quarter. The current assessment component is forecast to rise to 107.5 from 106.8, but the expectations component is seen falling to 104.3 from 105.5. Of course, Germany is very much supporting growth in Europe, and it’s the periphery areas which are the cause of most of the concern. That concern was piqued again yesterday after Ireland had its long-term credit rating cut one notch to AA- by Standard & Poor’s, who cited the cost to the government of supporting the domestic banking sector. S&P estimate that cost at as much as 50bln euros, up from a previous estimate of 35bln. Ireland’s own debt agency questioned the analysis used by S&P. The spread between Irish 10-year debt and Germany’s benchmark bunds rose 13 bps to 317bps.

Elsewhere in Asia India’s central bank said controlling inflation was its top priority, fueling speculation of another rate hike next month. The Reserve Bank’s annual report for the year ended June 30 said ‘inflation containment may have to receive precedence over the other policy objectives.’ The central bank of India tightened policy last month by raising the reverse repo rate 25 bp to 5.75%, the fourth tightening move in five months. The next meeting is Sept 16. Inflation is showing signs of cooling, but still from a high level – July’s wholesale price inflation was the slowest in six months at 9.97%. The central bank last month raised its 2010 GDP forecast to 8.5% from 8% and lifted its inflation forecast to 6% from 5.5%. Manufacturing and exports have been performing strongly, while bank lending last month stood 21% above year ago levels, the strongest pace since Jan 2008. Foreign investors have been particularly active, purchasing both stocks and bonds.  Foreign purchases of Indian equities was about $3.8 bln in July, which is more than a third of the amount bought year-to-date.  This itself is a 40% increase above year ago levels. India’s 10-year yield stands at about 7.95% today, having hit a three month high earlier this week above 8%.  Compared with other countries in emerging Asia, this is the highest yield alongside Indonesia.  India’s 2-year yield however is markedly higher than any rivals in the region ay 6.87% — Indonesia is closest at 5%. Elsewhere, South Korean consumer confidence fell for the first time in five months in August. The Bank of Korea’s index of sentiment fell to 110 from 112.

Upcoming Economic Releases
Asia Pacific: Thailand interest rates, Sri Lanka trade. Europe/EMEA: German IFO index, Spain producer prices, Sweden consumer/manufacturing confidence, Norway unemployment, Hungary retail trade. Turkey industrial confidence. Americas: US durable goods orders, new home sales, Mexico Q2 GDP, current account, unemployment.