Japanse GDP Contracts - Will Fed React?

Market Drivers August 17, 2015

Euro tests 1100 but recovers
Japanese GDP leaves concerns about BOJ policy
Nikkei 0.49% Europe 0.31%
Oil $42/bbl
Gold $1117/oz.

Europe and Asia:
JPY Prelim GDP -0.4% vs. -0.5%
EUR Trade Balance

North America:
USD Empire Manufacturing 08:30
CAD Foreign Security Purchases 08:30

It's been a typically quiet start of trade in the currency market today, with summer doldrums fully upon us as the global eco calendar is sparse at best and many market participants are at the beach rather than at their screens.

The only release of note was the preliminary Q2 Japanese GDP figures which showed that growth contracted at an annualized rate of 1.6%. This was a bit better than the -1.8% forecast by the market but small comfort to the Abe administration which was hoping for much better results as this point of it stimulus program.

The lack of demand was broad based indicating that despite the massive monetary stimulus by the BOJ - the Japanese economy is seeing no pick in economic activity. Although Japanese workers have seen modest wage increases, their propensity to spend did not rise leaving consumer demand lackluster at best.

The recent devaluation of the yuan will only exacerbate the situation as Trade took 1,1% off growth in the last quarter. The slowdown in China is having an outside negative impact on the whole of Asia Pacific region but especially so on Japan which sees nearly 30% of its trade weighted goods going to China.

It's unclear if BOJ will engage in any additional stimulus as the year proceeds, but the sharp decline in Chinese demand has created a new set of problems for Japanese policy makers as they try to stage a sustained recovery that has eluded the country for decades.

Against such a background its becoming increasingly difficult to see the Fed take any tightening action in September. With Europe essentially flat lining and Asia now experiencing negative year over year growth, the US remains the only region in the world that shows any growth at all. Although the US economy is relatively insular generating 85% of GDP internally, the Fed may not want to exacerbate the global economy by tightening rates amidst a broad slowdown in demand.

This may be one of the reasons why the buck has failed to gain any traction. The EUR/USD did take a dive in Asian session trade on the back of hedge fund selling, but a break of 1.1100 was bought and the pair was trading essentially unchanged at 1.1115 by midmorning London dealing. If the market becomes convinced that September hike is off the squeeze in the pair could take it past the 1.1200 highs of last week and target a much deeper retracement towards the 1.1400 level over the next few weeks.