Japanese Yen Surges as Stocks Drop on Election Results, China Bank Earnings (Euro Open)

The Japanese Yen surged sharply higher to start the trading week as stocks fell after an election brought the Democratic Party of Japan into power for the first time ever, boosting uncertainty about economic policy, while China’s shares dropped to a three-month low on disappointing earnings from China Merchants Bank.

Key Overnight Developments

• Japan: Industrial Production, Retail Trade Top Expectations; Manufacturing Expands
• Australia’s Business Loans Grow the Least in 7 Years, Company Profits Tumble
• New Zealand Business Confidence Rises to the Highest in Over a Decade
• Japanese Yen Surges as Stocks Drop Overnight on Earnings, Japan’s Election

Critical Levels

The Euro traded sideways in a narrow 30-pip range above 1.4290 in overnight trading. The British Pound trended lower after a brief test above the 1.63 level early in the session, giving up 0.2%. Technical positioning suggests the US Dollar is carving out a bottom against most major currencies.

Asia Session Highlights

The initial estimate of Japan’s Industrial Production showed that output added 1.9% in July from the previous month, more than economists expected but the least in four months. In annual terms, the pace of decline moderated to -22.9%, the slowest rate of contraction since December 2008. Output has rebounded from the lows noted in February as firms began to replenish inventories that had been depleted after sharp production cuts kicked in as overseas demand for Japanese cars and electronics began to drop off in March last year amid the deepening global economic crisis. Indeed, the Nomura/JMMA PMI gauge printed at 53.6 in August, showing that the manufacturing sector expanded for the second consecutive month. However, a sustainable upturn will have to come with growth in underlying demand, which seems destined to remain sluggish for some time. Indeed, the International Monetary Fund (IMF) said its latest world economic outlook that global trade volumes are likely to rebound just 1% having shed a whopping -12.2% in 2009.

Meanwhile, Japanese Retail Trade unexpectedly fell just -2.5% in the year to July, the smallest drop since January. Economists had predicted a -3.5% decline ahead of the release. However, the improvement in the headline figure may not be indicative of a true rebound in consumer sentiment. Indeed, most of the improvement seems to have been driven by a 7.6% jump in motor vehicle sales, which can likely be chalked up to tax breaks on purchases of fuel-efficient cars that were included into the government’s fiscal stimulus package. Looking ahead, continued weakness in the labor market is likely to keep a lid on spending as layoffs weigh on disposable incomes.

Australian Private Sector Credit grew 0.2% as expected in July, driven by a 0.84% jump in loans for new house purchases, the largest increase since April of last year. Separately, the Housing Industry Association reported that New Home Sales grew for the second consecutive month in July, adding 0.1%. The improvement is suspect however, having likely owed to fiscal stimulus rather than improved consumer confidence as the government extended a scheme offering an A$21,000 grant for first-time home buyers in May. Most worryingly, business loans grew just 0.5%, the least in over 7 years, while Operating Profits fell by a nearly twice as much as economists expected in the second quarter. A meaningful economic recovery will not materialize without a rebound in private consumption. This, in turn, requires a rebound in the labor market, which seems highly unlikely if firms are not able to either earn or borrow adequate funding for expansion. On balance, this could translate into a double-dip recession as the inherently temporary boost from fiscal stimulus begins to fade.

In New Zealand, NBNZ Business Confidence rose to 34.2 in August, the highest in over a decade. However, as we noted in our New Zealand Dollar Weekly Forecast, improvements in the headline figure may be misleading. The higher reading implies that optimists are outnumbering pessimists by an increasingly wider margin among polled survey respondents, but this is no tall order considering the New Zealand economy has been shrinking for six consecutive quarters and could prove to be flimsy evidence of a sustainable recovery in economic growth. Put another way, the relative improvement in firms’ optimism is more so a factor of the sharp declines in the recent past rather than a meaningful surge in confidence about the future.

The Japanese Yen surged sharply higher, with a trade-weighted index of the unit’s average value adding 1.2% from Friday’s close as stocks tumbled 2% in Asian trading to boost demand for the safety-linked currency. Chinese shares led the selloff, dropping over 5% to a three-month low, as China Merchants Bank (the nation’s fifth largest lender by market value) reported a third consecutive quarter of falling profits and set aside additional funds to cover future loan defaults. Japanese stocks slipped nearly a full percentage point as an election swept the Democratic Party of Japan into power for the first time ever, raising uncertainty about the practical impact that the change of leadership will have on economic policy.

Euro Session: What to Expect

A preliminary estimate of the Euro Zone Consumer Price Index is expected to show that inflation fell at an annual pace of -0.3% in August, a slight improvement over the -0.7% result registered in the previous month. Still, the bottom line is that prices are set to decline for the third consecutive month, contributing to building expectations of lower prices in the future. This threatens to unleash a deflationary spiral that sees consumers and businesses perpetually hold off on spending and investment as they wait for the best possible bargain, bringing economic growth to a virtual standstill. At this point, a survey of economists polled by Bloomberg suggests the market sees CPI shrinking through the third quarter and returning to a path of positive growth by the end of the year. If this proves to be too rosy, traders may punish the Euro as it becomes clear that the currency bloc is heading for a long-term period of low interest rates and sub-par economic growth. A disappointing outcome seems likely considering the European Central Bank’s apparent inability to offer effective monetary easing as well as well-founded reservations about the sustainability of the upswing in economic growth seen in the second quarter.

Written by Ilya Spivak, Currency Analyst
Article Source – Japanese Yen Surges as Stocks Drop on Election Results, China Bank Earnings (Euro Open)