BoJ's Decision Has Global Ramifications

The Bank of Japan's decision last night to deny Japan of additional stimulus triggered a wave of deleveraging that has driven currency and equities sharply lower. Today is perfect example of how the actions of the Japanese have global ramifications. We have long warned that the steep losses in the Nikkei point to a potential correction in U.S. stocks but up until yesterday the losses have been modest. Currently equity futures are pointing to a weak open for the U.S. markets, which is evidence that Japan's decisions have global ramifications. By refusing to increase stimulus in the face of rising volatility in the Nikkei, JGB and the Yen, the BoJ is testing its luck with the market. Based on the price action over the last 12 hours, investors are clearly not happy with the central bank's decision and if the Yen continues to rise and equities and bonds continue to fall, the BoJ will be forced to act.

FX Volatility
The lack of U.S. data in the front of the week has not translated into a lack of volatility for the U.S. dollar or the FX market in general. There is no consistency in the movement of the greenback but there is consistency in the risk appetite of investors. The Japanese Yen has appreciated anywhere between 1.5 to 3.5% against all major currencies and the Australian dollar is down another 1.25%, dropping to its lowest level against the U.S. dollar in more than 1.5 years. The New Zealand has also fallen another 1.6% to a fresh one year low.

While these moves are substantial the global ramifications of the BoJ's decision is more important. Investors around the world have been watching the volatility in Japanese markets for the past month and selling their stocks and bonds slowly. Today, there is only one reason why U.S. and European markets are performing so poorly and that is because of the BoJ's actions. The Nikkei may have only experienced a 1.5% slide overnight but Nikkei futures are down sharply this morning along with U.S. equity and bond futures. By denying Japan additional stimulus, they are denying the world much needed support for one of the most important economies in the world. They are also sending a strong message to the market that central banks won't be held hostage by market volatility so don't expect the spigots to be opened every time rallies are reversed. Once again, we fear that the BoJ is playing with fire and will end up being burned badly.

Policy Matters
In yesterday's note Yen Selling: Is 2013's Best Trade Over? we talked about how the next few percentage moves in USD/JPY will be determined by the direction of U.S. and Japanese monetary policy. Not only did the BoJ fail to increase the frequency of JGB purchases but they also did not extend the maximum duration of its funds supply operation from 1 to 2 years, which was the minimum the market expected. This was a conscious decision on the part of the BoJ to ignore the turbulence in the market. Instead, BoJ Governor Kuroda confidently said that weekly asset purchases would be sufficient to lower volatility over time. With monetary and fiscal policy proving to be less aggressive than Prime Minister Abe once promised, we could see further gains in the Japanese Yen and additional deleveraging in the Yen crosses along with the global financial markets before the dust settles.

Downside momentum in USD/JPY remains strong with last week's low of 95 being the critical level of support for USD/JPY. As for the AUD/USD, which has broken below its 2011 low, there may be some support at 0.9150, the 38.2% Fibonacci retracement of the 2008 to 2011 rally that took the pair from a low of 60 cents to a high above 1.10.