Did Yen Traders Overreact or is USD/JPY 105 Next?

It took no more than 3 minutes for USD/JPY to fall 300 pips with the sell-off spilling over to the yen crosses. The meltdown in USD/JPY was driven by the Bank of Japan's failure to add stimulus and indication to the market that they wanted to wait and see how negative interest rates affect the economy before easing again. Today's 3% decline took USD/JPY within pips of its 18-month low set in April and many contrarians are looking at today's move and wondering if investors are overreacting to last night's Bank of Japan announcement.

The last time the Yen rose this much was in late August when the Shanghai Composite Index plunged sharply, triggering concerns about regional growth and the Fed's ability to raise interest rates in September. The current backdrop is very different because the markets are stable and risk aversion is limited. Today's comments indicate that the BoJ is in no rush to increase stimulus, but having lowered their inflation and growth forecasts and pushed out the date by which they expect to reach their inflation target, the central bank still remains dovish. Kuroda expressed concerns about weakness in consumer spending, output and exports and warned that the BoJ could still ease in all 3 dimensions (quality, quantity and rates) if needed. In other words, the BoJ is still on track to increase stimulus this year especially after last night's weak inflation numbers.

However just because we expect the BoJ to ease again doesn't mean that we don't anticipate further losses in USD/JPY. The main takeaway from the BoJ meeting is the Japanese feel no immediate pressure to use monetary policy or currency intervention to turn around the economy. They feel like they've done enough for the time being and want to see how the economy reacts first. If the BoJ did not intervene in April and passed on cutting rates last night, they won't be intervening now unless USD/JPY drops to 105. They are clearly passing the baton to Prime Minister Abe and pressuring the government for more aggressive fiscal stimulus. If USD/JPY breaks below the April low of 107.63 (and we think it will), the next stop will be 106.65, the 38.2% Fibonacci retracement of the 2011 to 2015 rally.

The second best performing currency next to the Yen was the New Zealand dollar, which also benefitted from misaligned expectations. The RBNZ left monetary policy unchanged and like the BoJ, they maintained a dovish bias, saying that further policy easing may be required and that a lower New Zealand dollar is desirable. Nothing they said removes the possibility of additional easing and recent data only encourages the need for it but a subset of investors were positioned for a rate cut and when the RBNZ failed to deliver, they bailed out of their positions, sending NZD/USD sharply higher. Gains in the New Zealand dollar also helped to lift the Australian dollar but tonight's inflation report could sap some of those gains.

USD/CAD fell to a fresh 8 month low as oil prices climbed to its strongest level in 4 months. Oil is above $45 a barrel and that goes a long way in helping Canada's economy recover. February GDP numbers are scheduled for release tomorrow. While economists are looking for a decline in growth, the recent uptick in consumer spending leaves room for an upside surprise that could drive USD/CAD below 1.25.

The U.S. dollar ended the day lower against all of the major currencies despite mixed GDP data. Growth in the first quarter slowed to 0.5% from 1.4% and while this was weaker than expected, personal consumption and the GDP price index beat expectations. Jobless claims also continued to fall but the decline in Treasury yields tell us that investors are not convinced that these reports increase the chance of June tightening. Personal income, spending, Chicago PMI and revisions to the University of Michigan consumer sentiment report are scheduled for release on Friday but none of these numbers are significant enough to turn the dollar around.

The British pound resumed its rise against the U.S. dollar after a one-day pullback. The February high of 1.4670 remains the initial target for the pair. Unsurprisingly, sterling shrugged off slower house price growth and if tomorrow's mortgage approvals and net consumer credit numbers are weak, will ignore those as well. Gains in the currency were supported by optimistic comments from Bank of England Governor Carney. The central bank head acknowledged that the U.K. economy appears to be slowing in the very short term but he believes it is performing pretty well with wages expected to pick up. He warned about the risk of the E.U. referendum but it fell on deaf ears.

Finally, stronger economic data from the Eurozone provided a minor boost to the euro. German unemployment declined 16k in April, keeping the unemployment rate steady at 6.2%. Consumer prices in Germany declined but economic confidence in the Eurozone increased, led by gains in the industrial and service sectors. German retail sales are scheduled for release tomorrow but the main focus will be on first quarter Eurozone GDP and April CPI. Growth is expected to have accelerated in the first 3 months of the year but if that fails to be true, euro will give up its gains.