USDJPY - What to Expect from the Bank of Japan

After a 3-day consolidation, USD/JPY broke to the upside ahead of the Bank of Japan's monetary policy announcement. No policy changes are expected but Japanese 10 year bond yields fell to their lowest level since 2016, which tells that investors are bracing for dovishness. The big question for the BoJ tonight is whether the deterioration in trade warrants an adjustment in their economic assessment. Japan reported its largest trade deficit in 6 years as exports fell for the second month in a row. While the Lunar New Year in China may have affected demand, this is the largest decline in exports to China in 2 years. Like many countries around the world, Japan is hit hard by slower global growth but the world's third largest economy is particularly vulnerable ahead of this year's scheduled sales tax hike. However with the financial markets stabilizing, the Federal Reserve slowing tightening, and China adding stimulus the outlook is not grim enough to warrant easing. We expect the BoJ to lower their assessment of output and exports and leave it at that, but that may still be enough to extend the slide in the Japanese Yen and encourage gains in USD/JPY.

Investors largely ignored today's US economic reports. Import and export prices rose more than expected but jobless claims ticked higher and new home sales fell -6.9%. The drop in new housing demand is worrisome but could be distorted by the government shutdown. With inflation, employment and housing market activity slowing, the Federal Reserve who meets next week has no reason to alter there "patient" rate stance. The dollar shrugged off these reports because even though growth in the US remains weak, the uncertainty for other countries is even greater. Also, Friday's Empire State manufacturing index and University of Michigan consumer sentiment survey should be stronger given the strong move in equities at the end of February.

We're publishing our note before the outcome of the this week's last Brexit vote but support for an extension of Article 50 is pretty much ensured. Lawmakers rejected Prime Minister Theresa May's withdrawal agreement and a no deal Brexit so the only path forward is to go to the European Union, request an extension and use that time to figure out their next steps. Sterling pulled back today because a request to delay Article 50 leaves the UK right where it started. The only difference is that May can no longer hang the threat of a no deal over everyone's heads even as she tried after the vote on Tuesday by saying technically no deal is still the default until there is an agreement. The European Union will grant the UK an extension but the question is for how long. If the UK seeks a short delay of say 2 months, GBP traders will be disappointed because if they can't a reach a deal in more than 2 years, there's very little chance that an agreement will be made by June. If the extension is for a year or more, we should see rocky relief rally in GBP. Based on EU President Tusk's comments today, they prefer a long than short delay. He tweeted "During my consultations ahead of the #EUCO (EU Summit), I will appeal to the EU27 to be open to a long extension if the UK finds it necessary to rethink its Brexit strategy and build consensus around it."

After rising for 4 straight days, euro followed sterling lower. The commodity currencies also sold off and their moves were compounded by softer Chinese data. According to the latest reports, the Chinese economy isn't getting any better. Consumer spending growth slowed to 8.2% in February with industrial production growth easing to 5.3% from 6.2%. While part of this could be attributed to the Lunar New Year holiday, the weakness in China is irrefutable and with the meeting between Trump & Xi expected to be pushed back to April at the earliest, it doesn't look like we'll get a trade deal anytime soon.  None of this is good for the Australian and New Zealand dollars, which previously benefitted from trade deal optimism.