US Data; When Will BoJ Cry Uncle?

This morning's U.S. economic reports have taken a backseat to the massive rally in the Japanese Yen and the ugly decline in Japanese stocks overnight. The Nikkei fell another 6%, adding to losses that now exceed 20%. While European traders are rightfully spooked by the steep slides in Asian markets, U.S. traders have continued to ignore the volatility and the impact that it should have on risk appetite and the U.S. markets. Today's retail sales report only gives them a stronger reason to be in denial as they can attribute the resilience of U.S. stocks to the stability of the U.S. economy. U.S. equity futures are actually in positive territory this morning, having recovered earlier losses following the stronger retail sales and jobless claims reports.

The data suggests that the recovery in the labor market is finally fueling momentum in consumer spending. Retail sales increased 0.6% in the month of May, up from 0.1% in April. However excluding autos and gas sales, retail sales rose 0.3%, down from 0.5% the previous month. Sales in April were also revised down from 0.6% to 0.5%. This means that today's report on consumer spending is not unambiguously positive which explains why USD/JPY barely budged off of the release. As we said in yesterday's note retail sales needed to exceed 1.5% to save USD/JPY from its current collapse. Even the drop in jobless claims from 346K to 334K failed to lift USD/JPY because the meltdown in the Japanese Yen crosses is just too strong.

When Will BoJ Cry Uncle?
So the question now is when the Bank of Japan will cry uncle. Both Japan's BoJ Governor and its Finance Minister are new members of Shinzo Abe's government. Granted Kuroda formerly served as the head of Asia Development Bank and Aso was a former Prime Minister, both men may be struggling to deal with the volatility in Japanese markets. On an absolute level, USD/JPY is still well off its record low of 75.57 but we haven't seen this type of volatility in the Nikkei since 2011, shortly after the earthquake and tsunami that devastated Japan. At the time, USD/JPY and the Nikkei was "saved" by G7 intervention but even though Abenomics will most likely be discussed at the next G7 meeting, the Japanese can't expect any help from their global partners because this time, they only have themselves to blame for denying Japan additional stimulus this week and sending their markets into a downward spiral.

Last night's Ministry of Finance flow of funds report show Japanese investors selling foreign bonds once again. With the Japanese continuing to repatriate their funds, their actions are driving USD/JPY lower and not higher. Stocks have also peaked in Japan and U.S. bond yields are lower, all of which contribute to USD/JPY losses. So while Abenomics is suppose to be positive for USD/JPY, so far, we have not seen its expected effects on Japanese investments, JGBs and the Nikkei, critical factors that contribute to the trend of USD/JPY.

With today's move the currency pair has fallen more than 8% from its May 22 high so how much additional losses are needed before the BoJ cries uncle and verbally or physically intervenes to drive down the Yen? Based on the percentage move and how quickly it has occurred, the BoJ should be at least trying to talk down the currency. However they have only defended their actions and part of the reason may be because last week's CFTC data showed speculators net short and not long Yen. The BoJ is a street smart central bank that likes to wait for short USD/JPY positions to build up before verbally or physically intervening to get the most bang for their buck. At 95, many investors may have abandoned their long USD/JPY positions but at 90-92, we may start to see some investors short the currency and that is what the BoJ wants to see. For the sake of the stock market, we think the Japanese government should act now but their stubbornness over confidence and current policies could be clouding their good judgment.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.