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There were extraordinary expectations that the Bank of Japan had to roll out something really big when they met in late April, but they didn't, since then I think there has been a realization that policy reactions in Japan are perhaps not to be expected anymore - big, market-moving policy reactions. Once the market begins to accept this, and to lower expectations for fireworks and bazookas, we can start the process of re-calibrating Japan based on its relationship with global fundamentals.
I think the market remains open to all possibilities right now, we're in a low-turnover state of anticipation over global events like the Brexit vote and the FOMC meeting but also with regard to domestic elements like a possible delay of next year's consumption tax increase and a possible snap election this summer. There's a lot of noise and no clear decisions.
I think it's hard to argue that the weakness we've seen in Japan this year has had to do with fears of a VAT hike and I think investors are much more focused on world events, right now, Japan is at the mercy of how China risks evolve, how expectations regarding Fed rate hikes evolve, and how the Brexit vote evolves.
The market's initial reaction to the GDP data was a slight strengthening of the yen, japanese policy makers could really use a sense of crisis to help justify ramping up fiscal stimulus or pushing out the VAT (sales tax) hike and a stronger GDP figure seems to undermine that narrative, though there is also some buoyancy from stronger U.S. inflation and increased expectations for Fed rate hikes.
We're seeing a double whammy of yen strength combined with Japan Inc's tendency to give very conservative guidance, so you have to acknowledge some uncertainty over how much capex will actually be impacted by the stronger yen because we're unsure just how much exaggeration we're seeing in dim earnings forecasts.
The U.S. dollar remains doggedly below 110 yen, which will cap any notions of a sustained rebound, we're unlikely to see more conviction behind further yen strength or weakness until after next week's big Fed and Bank of Japan meetings, which means for now the market will remain influenced predominantly by micro- and near-term events, the most obvious being earnings.
We're seeing a perfect storm of the kind of negativity that feeds into people's fears and underscores the dangers lurking in a market where sentiment is very sensitive, it's unsurprising the yen's recent weakness has reversed given the sour macro sentiment arising from events like the natural disaster, the failure of the OPEC meeting to follow through on the encouraging promise it had shown, as well as smaller geopolitical risks like the impeachment going on in Brazil.
We've had a decidedly more bullish mood these last few days, with a bit of encouragement coming from oil prices, a bit of encouragement from China's trade data, and the yen is obviously playing a factor, these are all very encouraging signs that at the very minimum indicate that selling pressure has eased, and which hopefully mark some degree of more sustainable optimism. But that's hard to say for certain given how many people got caught on the wrong side of false dawns and dead cat bounces last quarter.
Throughout March, Japan failed to respond to rallies and improving risk appetite seen in the U.S. and elsewhere, and while some were hoping Japan would catch up, the past few days have opened up the possibility that the rest of the world may catch down instead, the market is now posing big questions of Abenomics.
In U.S. dollar terms, Japan is significantly underperforming versus the U.S. and some of that may have to do with the fact that it's the end of a financial year and the end of a financial quarter that has been particularly harrowing, so much money in Japan is institutional and for that reason institutional frames of mind prevail, which can cause things to slow down at certain times of year.
There's a general sense of caution as we look ahead to tomorrow's CPI and as we approach the end of the month, which is actually the end of the financial year for most listed stocks, it would unquestionably be more desirable for policymakers in Japan to end the month on a higher note than we're seeing right now. Unless the yen weakens substantially between now and the end of March, I imagine the Nikkei will have a hard time holding its current position.
The ECB decision is seen as very positive now that markets have digested what it all means, but conviction perhaps isn't as strong as it should be as investors exercise a bit of caution, i don't think investors are expecting anything drastic from the BOJ, especially given the fact that they are meeting before the FOMC and will be reticent about making a big aggressive gamble ahead of a Fed meeting.
Following the selloff and the fears of recession that emerged early in the new year, people pulled back aggressively from their previous expectations about how a rate hike from the Fed might unfold, suddenly some of this lost confidence has been restored as we've seen a lot of recent economic data from the U.S. beating expectations.
Following the selloff and the fears of recession that emerged early in the new year people pulled back aggressively from their previous expectations about how a rate hike from the Fed might unfold, suddenly some of this lost confidence has been restored as we've seen a lot of recent economic data from the U.S. beating expectations.
There's no question that the U.S. has experienced a substantial rebound and that has set the tone for this morning's trading in terms of instilling confidence in the broader outlook, that the market has chosen to focus on U.S. strength rather than Japan's weak January trade data suggests that a lot of negativity had already been priced in, which isn't surprising considering the terrible sell-off we saw in the beginning of this year.
The rally itself has been extraordinary but very thin and the failure of the yen to continue on the fairly steady path of weakening we've seen in the past couple of days has been reflected as nervousness in the Nikkei, it's been a very volatile two weeks and nerves are still frayed despite the fact that we're off the bottom of those extreme sessions we saw last week.
Extreme volatility has been the order of the week and even an encouraging recovery in U.S. stocks overnight hasn't been met with much conviction, which reflects how investor sentiment seems to have turned, last year we saw more willingness to buy on dips and it's a key change that the market seems to view rallies with suspicion so far this year. The question is whether that suspicion runs shallow or deep.
The weakening of the Chinese RMB seems to have spooked the yen and by extension the Nikkei in an already nervous and shell-shocked market that's worried about dynamics both economic and geopolitical, in these last couple of days the yen has moved in a way that chartists have called a break from the weakening trend of Abenomics that we've seen for the past few years, and in that kind of environment the market becomes incredibly vulnerable to events like the RMB failing to stabilize.
The movement has been a bit choppy and a little bit disconnected during these past few days, partly because of the recent holidays and partly because of end-of-month related activity we have had a fairly susbstantial recovery since the end of September, but the market is still in a state of anticipation ahead of the FOMC. We've been in rehearsal mode for a long time and it's created a huge amount of nervousness and volatility, but now it's showtime.
The Nikkei has been closely reflecting the yen's moves this week so the bit of strengthening we saw in the yen overnight seems to have brought the mood down slightly this morning, but we've also got a three-day weekend coming up in Japan and it's not unusual for that to dampen risk appetite after a long week full of activity.
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