Yen Strength Signals Corrective Phase

While the case for further Yen weakness remains compelling, it’s hard to argue against a period of natural consolidation after an extended period in decline. The USD/JPY retreated from two-and-a-half-year highs overnight edging back below the 88-handle to lows of 87.61. The exception however was against the in-form Kiwi which managed to remain buoyant while forging further gains against the greenback. After rising to fresh four-year highs against the Yen, the Aussie dollar retreated back below the 92-handle. Looking to the majors, the theme of U.S. dollar weakness prevailed with the kiwi leading a move higher from the risk spectrum.

From here, Yen pundits will be watching the headlines ahead of the Bank of Japan policy meeting to be held January 21-22, when it’s expected the Bank will take heed of Prime Minister Shinzo Abe’s calls to implement a new 2% inflation target.

Reports doing the rounds yesterday suggest the Abe government will go on a stimulus offensive to the tune of $5-billion to revive investment in the region in an effort to spur economic growth. According to a draft report acquired by Reuters, the government will invest 4.9 billion in fiscal initiatives, adding to Japan’s mounting of debt. Among advanced and emerging economies, Japan is the undisputed champion of the debt race, with current estimates showing the public debt equating to an alarming 235 percent of GDP and projected to rise to 250% by 2017.

With a an already ambitious inflation target of 1% expected to doubled, Abe’s modus operandi is clear; kick start inflation and assassinate the Yen. By doing so Japan’s export-contingent economy stands to benefit from the increased competitiveness of a weaker currency. Time will tell if the Bank of Japan will cooperate with Abe’s objectives, but with current Governor Masaaki Shirakawa’s term expiring in April of 2013, one can expect a pro-stimulus ally to take the helm.

Debt Ceiling, 4Q Earnings In Focus
With little in the way of fundamental guidance, markets are looking forward to key earnings releases this week with industry heavyweights Alcoa and Wells Fargo due to report. After last week’s near 5% surge on the fiscal cliff work-around, there’s little in the way of ‘good news’ left to be priced in, amid an undertone of concern surrounding the next challenge for congress -- the debt ceiling.

President Obama summed up the importance of the lifting of the debt limit in his weekly address: If Congress refuses to give the United States the ability to pay its bills on time, the consequences for the entire global economy could be catastrophic. One thing I will not compromise over is whether or not Congress should pay the tab for a bill they’ve already racked up.

In short, we can expect intermittent bouts of negativity surrounding the debt ceiling in the near-term, but with the alternative likely to result in a market meltdown, we anticipate markets will continue to trade under the assumption a deal will be done. It would seem Republicans have little clout left given the political ramifications of obstructing a deal resulting in an effective government shut-down and ensuing market mayhem.

AUD Buoyant At 105
The Aussie dollar edged lower against major counterparts overnight, with expectation to the greenback, which trade both sides of $105 over the course of trade. At the time of writing the Aussie dollar on the cusp of the $105 level, albeit in light trading conditions which is likely exacerbating only moderate support.

Local data on today’s docket includes the November trade balance and RBA FX transaction for December. Australia’s trade deficit is expected to widen to 2.3 billion in November from a previous 2.088 billion. Today’s trade data -- although not likely to be a significant market mover -- will be closely watched as a barometer of export activity as markets continue to gauge demand from our larger trading partner, China.

Wednesday's CPI
Data on the health of the Chinese economy will be closely watched this week, with December CPI to kick off the proceedings on Wednesday. Also on the docket are producer prices, industrial production, fixed asset investment and retail sales, with new Yuan loan activity and trade data scheduled for release on Thursday.

Wednesday’s retail data will no doubt be a primary rates barometer, any another deviation to the upside of 0.3% growth estimates will no doubt encourage further scaling back of interest rate cut expectations. Last week, the balance swung back in favour of the RBA to hold in February, with interbank cash rate futures showing 41% chance of a 25bps cut, down from 63% at year end.

Across the Tasman, real flows kept the kiwi in solid form with the NZD/USD pair making a convincing break to the upside of $.83 once again, enabling the kiwi to remain buoyant against a broadly stronger Yen, while taking the lead against the Aussie.