Japan GDP tumbles on contracting domestic demand, what next?

Forex News and Events:

The Japanese GDP growth drops 6.8% q/q annualized according to 2Q preliminary report. The drop is mostly due to 2.8% contraction in domestic demand, while the GDP deflator significantly rises to 2.0% (from last quarter’s -0.1%). The effects of April sales tax hike (from 5% to 8%) is clearly detectable on today’s data. The Japanese consumer and business spending retreat 5.2% and 2.5% on quarter, respectively. The data is clearly not supportive of economic growth; however the Economy Minister Amari said that the government’s view doesn’t change post-data. The economic recovery will continue at modest pace according to Amari, once the sales tax effects are offset. After stabilizing below 200-dma in Tokyo, USD/JPY crossed above resistance as European traders walked in. The slowdown in Japanese recovery can only boost speculations for additional monetary stimulus. Although Shinzo Abe’s government, nor Kuroda’s BoJ don’t seem to lean towards this solution at this stage, Amari didn’t rule out the potential for a flexible action if needed.

Hopes are now on the anticipated rebound post-June. Moving forward, the market expectations are rather optimistic. According to a Bloomberg survey, economists are looking for 2.9% annualized growth in the third quarter, once the post-tax-hike depression is left behind. In opposition, we see little potential for improvement given the tardy growth in wages. Regarding at what happened in 2Q, the fundamentals do not give solid signals. In fact, the household demand dropped by a significant 19.2% from last quarter, showing that the pre-April data has been seriously deviated due to a heavy consumption before sales tax rose. While the structural reforms, Abenomics’ third arrow, don’t materialize, an additional wave of monetary easing cannot do miracles by itself. The only positive highlight is the supportive external demand as net trade adds to GDP growth for the first time since Abe implemented its massive easing policy to fight Japan’s two-decade stagnation.

Investors now question whether Abe may pull the second round of sales tax hike (from 8% to 10%) by the end of this year, rather than October 2015 as originally scheduled. We believe it critical for Abe to officially announce the end of deflation before proceeding with the next sales tax increase, simply to avoid a similar short-lived consumption rush observed pre-April followed by a quarter of depressed domestic demand.

USD/JPY forwards trade with discount, reinforced by traders’ additional downside preference outside of rate differential (this can be due to safe haven demand on geopolitical tensions, slow recovery in China and emerging Asia, etc.). The 3-month risk reversals are at highest levels since 2014, yet remain below zero unlike end-2012/beginning-2013 which has escorted more than 30% surge in USD/JPY. The pair is stuck between 100.76/105.44 since 2014 began and the range narrows as speculations for more stimulus fade. In the near term, we will be monitoring a breakout from 100.76/103.02 range to talk about fresh direction. Option bids dominate above 103.00/50 for month ahead. We still favor the long-side of the play mostly believing that Abe is not ready to abandon his fight to fuel the Japanese economy. In case the markets reverse tendency, more stimulus, sooner tax action (or new measures) should come to rescue to cool down a potential JPY strength.

Today's Key Issues (time in GMT):

2014-08-13T11:00:00 USD Aug 8th MBA Mortgage Applications, last 1.60%
2014-08-13T12:30:00 USD Jul Retail Sales Advance MoM, exp 0.20%, last 0.20%
2014-08-13T12:30:00 USD Jul Retail Sales Ex Auto MoM, exp 0.40%, last 0.40%
2014-08-13T12:30:00 USD Jul Retail Sales Ex Auto and Gas, exp 0.40%, last 0.40%
2014-08-13T12:30:00 USD Jul Retail Sales Control Group, exp 0.40%, last 0.60%
2014-08-13T13:00:00 CAD Jul Teranet/National Bank HPI MoM, last 0.90%
2014-08-13T13:00:00 CAD Jul Teranet/National Bank HPI YoY, last 4.40%
2014-08-13T13:00:00 CAD Jul Teranet/National Bank HP Index, last 163.98
2014-08-13T14:00:00 USD Jun Business Inventories, exp 0.40%, last 0.50%

The Risk Today:

EURUSD EUR/USD continues to hold at the lows but rallies have lost momentum. The proximity of the key support at 1.3296, a short-term rebounds are likely. Resistances can be found at 1.3444 and 1.3503 (05/06/2014 low). An hourly support stands at 1.3333 (06/08/2014 low). In the longer term, EUR/USD is in a succession of lower highs and lower lows since May 2014. The downside risk is given by 1.3210 (second leg lower after the rebound from 1.3503 to 1.3700). A strong support stands at 1.3296 (07/11/2013 low). A key resistance lies at 1.3549 (21/07/2014 high).

GBPUSD GBP/USD traded higher today off the recent lows. In the short-term,the key resistance at 1.6893 will be hard to break given the overextended rise. A break of the resistance at 1.6893 (01/08/2014 high) is needed to suggest exhaustion in short-term selling pressures. Another resistance can be found at 1.6955 (30/07/2014 high). In the longer term, the break of the major resistance at 1.7043 (05/08/2009 high) calls for further strength. Resistances can be found at 1.7332 (see the 50% retracement of the 2008 decline) and 1.7447 (11/09/2008 low). A key support stands at 1.6693 (29/05/2014 low, see also the 200 day moving average).

USDJPY USD/JPY continues to rise and is now challenging the resistance at 102.46 (07/08/2014 high). Hourly support can be found at 102.00 (07/08/2014 low) and key resistance is located 102.66 (06/08/2014 high). A long-term bullish bias is favoured as long as the key support 99.57 (19/11/2013 low) holds. However, a break to the upside out of the current consolidation phase between 100.76 (04/02/2014 low) and 103.02 is needed to resume the underlying bullish trend. Another resistance can be found at 104.13 (04/04/2014 high), while a major resistance stands at 110.66 (15/08/2008 high).

USDCHF USD/CHF displays many significant daily upper shadows near the resistance at 0.9107, suggesting strong selling pressures close to these levels. Monitor the support at 0.9041 (01/08/2014 low), as a break would invalidate the short-term bullish technical structure. Other supports can be found at 0.9008 (24/07/2014 low) and 0.8969 (17/07/2014 low). From a longer term perspective, the recent technical improvements call for the end of the large corrective phase that started in July 2012. The long-term upside potential implied by the double-bottom formation is 0.9207. Furthermore, the break of the resistance at 0.9037 calls for a second leg higher (echoing the one started on 8 May) with an upside potential at 0.9191. As a result, a test of the strong resistance at 0.9156 (21/01/2014 high) is expected.

Resistance and Support: