The Japanese economy continues to improve following better than expected Q2 GDP. The data had little impact on the yen but Asian equities finished broadly higher in a quiet much less volatile European trading session. Japan will likely continue to struggle with JPY strength given the actions taken by the SNB to weaken the Swiss franc and the commitment by the Fed to keep US interest rates at ultra-low levels. This will either require further intervention from the Ministry of Finance or a compromise by Japanese Industry to thrive in an environment of a strong JPY.
Q2 Japanese GDP fell -0.3% but the outcome was rosier than the headline portrays. Consensus expectations were for a decline of -0.6%. On an annualized basis GDP dropped -1.3% on expectations of -2.5%. Exports accounted for a majority of the weak GDP numbers but stronger than expected consumption, higher business inventories, and a bump up in construction spending after the earthquake/tsunami were enough to close the gap with markets’ expectations. The data is encouraging given last week’s better Tertiary Industry Activity (1.9% on expectations of 1.1%) and stronger core machinery orders (7.7% on expectations of 1.9%).
The better than expected GDP data comes at a time when the Japanese government could use the increased tax revenues that follow higher growth. The current administration is teetering on the edge of losing its AAA rating. Analysts from Rating & Investment Information, one of Japan’s two major rating agencies says the nation could lose its top rating unless the government reigns in its budget deficit and addresses the political instability of a revolving door at the Prime Minister’s office.
External forces are currently in favor of an appreciating Japanese yen. The Swiss National Bank looks to be taking further action to stem the tide of a strengthening Swiss franc. The SNB is in discussions to set a lower limit for the EUR/CHF above 1.10. This follows previous attempts to weaken the CHF via increased swap agreements with other European central banks, additional sight deposits, and negative interest rates. The moves by the SNB make the JPY the most likely candidate for real money safe haven flows.
Although Fed Funds futures showed the market’s expectations for a US rate hike were in not until winter of 2012, last week’s announcement by the Fed to keep interest rates near zero until mid-2013 might offer further USD weakness in the near term. Given the additional easing of US monetary policy put in place by Bernanke and the Fed, it will be a long uphill battle to book any gains in the USD/JPY.
The question is now how will Japan respond? After embarking on an estimated $50bn FX market intervention to stem the tide of a rising yen the MoF has only responded with tough talk and no follow up action. Japanese finance minister Yoshihiko Noda was quoted as saying, “As foreign exchange market matters are my prerogative, I will continue to closely watch the markets and take bold action if it becomes necessary.” This lends to the idea that further intervention in the forex market may be on the way.
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