There had been too many test-balloons concerning Japan’s upcoming monetary and fiscal easing programs over recent weeks. Extreme views expressed hope for helicopter money and the MOF launching a fiscal support program up to JPY30trn. Hence, there was room for disappointment when the usually well informed Nikkei reported the MOF may launch a fiscal stimulus of JPY 6trn.Whilesuch a package would still double the MOF’s real fiscal spending estimates it was far less than markets were hoping for. Fin Min Aso, who (according to reports in the Japanese press such as The Japan Times on July 23) is likely to survive he upcoming cabinet reshuffle, suggested it would leave actual policy measures to the BoJ, thus presenting the ‘wrong’ sound biteto those who believe in helicopter money.
Real rate differentials will continue driving JPY performance. From July 10th up to last Thursday, real rate differentials worked in favour of USDJPY .The perception of a better US economy and the equity market moving away from investing into dividends towards pushing funds into cyclicals pushed US real rates up. Around the same time, 10-year US real yields rebounded from -10bps to +5bps.Simultaneously, Japan’s real yields moved lower due to rising inflation expectations pushed higher not only by progressive fiscal and monetary easing expectations, but also by higher oil and commodity prices. However, yesterday’s sharp 2.5% oil price decline backed by oil demand for the third quarter of 2016 growing by less than one-third the rate it did in the same period of last year does not bode well for Japan’s inflation expectations. Oil has broken a significant chart level at 45.90 targeting 41.00,adding to USDJPY selling pressure. USDJPY has eased back from last Thursday’s 107.50 level into the 104 handle. Key support is now located at 104.40 and a break of this level would identify 107.50 as a corrective top followed by impulsive weakness taking USDJPY closer to our Q3 projection of 97.
There could be little reason for the Fed to disagree with current Fed funds market pricing of a 50% probability for the Fed hiking rates in December. We do not follow views urging the Fed to react to the recent improvement in financial conditions and better domestic data laying the foundation for an early rate hike. There is too much to lose for the Fed to act too early. Hence, it will be happy to sail behind the curve suggesting US real yields coming down weakening the USD. If the Fed does act too early then it may risk the equity market selling off, weakening financial conditions, putting it on the back foot again. The USD would fall in any case.
When the previously hawkish BoE MPC member Martin Weale turns dovish market participants better listen. UK data, especially from the supply side of its economy, has been weak with many soft indicators falling back to levels seen in 2008/2009.Weaker output is written on the wall suggesting weaker employmentand consumption to come. In order to minimise bearish implications, British authorities should implement supply supportive policies. Her ea weaker FX rate can help.