FX Daily: Yen Pares Gains, Dollar-Bloc Firms

Japanese officials may have ratcheted up their rhetoric a notch, but the ultimately it simply seems the yen buying dried up.  Either the demand at the beginning of the fiscal year has been met, or sharp yen rise encouraged buyers to pull back.  The dollar's upticks look corrective in nature, and it remains well within yesterday's range.  We peg initial resistance in the JPY109.30 area. 

Japan did report a larger than expected February currency account surplus.  It rose to JPY2.435 trillion, the most since March 2015,  from JPY520 bln in January.  The consensus was for a JPY2.032 trillion. To be clear, the driving force was not the trade component.  The JPY425.2 bln trade surplus was actually a little smaller than the consensus expected.  The investment income surplus was JPY2 trillion.  

The previously weak yen did not give much of a boost to the volume of Japanese exports.  The impact from the strong yen will probably not be felt acutely on trade, but on the value of the capital flows.  The coupons and dividends earned offshore will simply translate into fewer yen.  The same is true of Japanese corporate earnings from abroad.

Since the last 1990s, Japanese data indicates that local sales by foreign affiliates of Japanese multinationals have outstripped Japanese exports.  Contrary to conventional wisdom, Japan is not an export-oriented economy.  Its exports, as a percentage of GDP, roughly in line with US exports, which, proportionately, are less than half of German and Swiss exports, for example.

Given the talk of currency wars,  we argue Japanese officials should be commended for having not intervened in the foreign exchange market in the face of the counter-intuitive, and ultimately counter-productive yen appreciation.  Given the weak growth prospects and lingering deflationary forces, a tightening of financial conditions is one of the last things Japan's economy needs. 

Many observers seem to miss this point.  Instead, when intervention did not materialize around JPY110, many have simply changed their trigger to JPY105, and some JPY100.    We argue it is mistaken to think that Japanese officials will defend any particular level.

Moreover, in the current situation, and especially the questions raised following the BOJ's surprise adoption of negative interest rates at the end of January, we understand that Japan would need to consult with its G7 partners about intervention.   Given that there has been no G7 intervention since the coordinated operation in 2011 (following Japan's tragic earthquake and tsunami), and that fact that there was no intervention during the volatile 2008-2009 Great Financial Crisis, the bar to material intervention in the foreign exchange market is high.  In fact, it is sufficiently high that this week's yen surge does not meet it.

The market was given a handy reason to sell sterling today, but it failed to take the bait.   The reported dreadful industrial output figures.  Industrial output for February was expected to have risen by 0.1% and instead if fell by 0.3%.  Adding insult to injury, the January series was shaved to 0.2% from 0.3%.  More troubling was the 1.1% drop in manufacturing output.  It is the largest decline since May 2014.  The market had anticipated a 0.2% decline.  The January series was revised to 0.5% from 0.7%.  The year-over-year pace is -1.8%, which is the largest decline since July 2013. 

Separately, the UK reported another larger than expected trade deficit.  The goods trade deficit came in at GBP11.96 bln, which was more than 10% larger than expected.  The overall trade balance was GBP4.84 bln, which was nearly a third larger than the Bloomberg consensus.  The goods deficit with the EU stood at GBP23.8 bln in the three-month through February, which is the widest since the time series began in 1998.The macro-picture is one of a larger than expected budget and trade deficit in early 2016, and as weakening industrial sector. 

Sterling is holding onto minor gains today, largely confined to yesterday's ranges.  On the week, it has lost about 1% against the US dollar and euro.  The $1.40 level held at midweek and the rebound has been limited by $1.4170.  The Bank of England meets next week but most likely won't change policy.  The UK reports inflation measures next week as well.  A small uptick in CPI is anticipated.