The Ying and Yang of Yen and Cable Trade

Market Drivers November 12, 2014

USD/JPY pops through 116.00 but then quickly retreats on conflicting reports of flash Japanese elections
UK Unemployment rises but wages rise as well
Nikkei 0.43% Europe -.86%
Oil $77/bbl
Gold $1163/oz.

Europe and Asia:
AUD Westpac Sentiment 1.9% vs. 0.9%
EUR German WPI -0.8% vs. 0.2%
GBP Average Claimant Count -20.4K vs. -24.9
GBP Unemployment 6.0% vs. 5.9%
EUR IP 0.6%
BoE Inflation Report dour

North America:
USD Wholesale Inventories 10:00

The yen was pushed and pulled in Asian session trade today as traders reacted to a slew of conflicting reports regarding the upcoming second hike in the Japanese sales and the prospect of snap elections. USD/JPY soared to fresh multi-year highs of 116.00 on rumors that PM Abe may delay by 18 months the implementation of the second round of sales tax hikes.

Sankei Shinbun, the primary business newspaper in Japan reported that PM Abe would dissolve Parliament within a month to call a snap election. Those rumors have been floating in the forex market since the weekend and although Mr. Abe popularity has waned in the past year, a quick election would likely result in a victory for his party as there are no palatable alternatives for the Japanese electorate.

If Mr. Abe were to consolidate his power then his all out policy assault on the deflationary forces in the Japanese economy would gain further momentum weakening the yen even more. That was the reason for jump in the USD/JPY pair, but the move quickly withered dropping to 115.30 when Japan's chief cabinet Secretary Suga stated that he was not preparing for elections at all. A Japanese government spokesman also denied speculation that the tax hike would be delayed.

Although snap elections in Japan are unlikely at this time, a delay in the sales tax hike might be wise especially if Mr. Abe wants to maintain inflationary momentum in the economy. The first tax hike caused an absolute contraction in Japanese consumer spending that lasted a good six months. Although the second tax hike from 8% to 10% would be a smaller increase it nevertheless will likely have another chilling effect on aggregate demand and it remains to be seen if the Japanese economy will be strong enough to absorb such a shock in a year from now.

Elsewhere the price action was centered on cable as the pair first rose after slightly positive UK Labor data but then quickly sunk below the 1.5900 figure post Governor Carney's rather dour message in the BoE Inflation report.

UK labor data showed that average earnings rose by 1.0% versus 0.9% continuing the slightly upward trend seen over the past few months. The news heartened traders who bid cable to 1.5940 on assumption that price levels were finally likely to pick up, but sterling quickly erased its gains when Governor Carney started making remarks on the BoE inflation report. Mr. Carney noted that the spectre of stagnation was haunting Europe and lowered the BoE projected inflation rate to 1.0% in 2015 suggesting that it will slowly return to 2% target.

He reaffirmed the central bank's commitment to normalizing rates, but stated that both the pace and scope of any rate hikes is likely to be smaller than initially anticipated. More importantly Mr. Carney implicitly confirmed the market's recent expectation that rate hikes will not begin until H2 of 2015 at the earliest. This schedule means that UK is unlikely to be "the first to hike" amongst the G-7 central banks and that expectation will keep cable under pressure for the foreseeable future. The pair continued to push lower into London late morning trade and could test support around the 1.5850 level as the day proceeds.