Fundamentally the Japanese economy continues to deteriorate on a longer time frame perspective. Tonight’s weak GDP performance which saw growth decelerate to 1.4% rate from 5.5% increase in H1 of this year is only the latest data point to surprise to the downside. More importantly the country’s vaunted Trade Balance position has declined markedly. Japan has run a trade account deficit for the past 15 consecutive months, yet the currency continues to attract safe haven flows despite its weakened balance sheet position. Granted Japan continues to enjoy a Current Account surplus, but even on that front, the country’s average monthly capital account flows have been running at half the pace of 2011.
One reason for such disconnect between Japan’s eroding balance sheet position and the strength of the country’s currency is the persistent fear that US Federal reserve will proceed with QE3 thus further diluting the value of the dollar. However, US monetary officials have been circumspect in their policy guidance and we very much doubt that they will pursue any action ahead of the US election in November. A key factor in their decision making process may be tomorrow’s US Retail Sales report. US Retail Sales numbers have been negative for the past three months, raising fears amongst investors that a dampening in consumption could tip the Us back into a recession. We believe that the drop-off in consumer demand was largely the result of a spike in energy prices which have since eased.
The markets are anticipating a rebound of 0.4% in Tuesday’s US Retail Sales report. Should the data meet or beat the forecast, it may go a long way towards alleviating fears of yet another round of QE and could serve a fundamental trigger for a more sustainable rally in USDJPY. However, if the news shocks to the downside with Retail Sales printing a negative result for the fourth month in a row, expectations of more QE will increase markedly irrespective of the political risks that such a move would entail.
One of the more durable truths of currency trading is that volatility tends to be mean reverting. Given the massive compression of movement in USDJPY it appears likely that the pair may break out in either direction sooner rather than later. This week’s US Retail Sales report may be the catalyst for the move.