The Nikkei’s latest meltdown and the sharp USDJPY losses that followed have the world wondering how much worse conditions will need to become before the Bank of Japan intervenes to stem the volatility.
This morning's US economic reports have taken a backseat to the massive rally in the Japanese yen (JPY) 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, US traders have continued to ignore the volatility and the impact that it should have on risk appetite and the US markets.
Today's retail sales report only gives more incentive to be in denial, as investors can attribute the resilience of US stocks to the stability of the US economy. US equity futures were 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%.
Overall, this means that today's report on consumer spending is not unambiguously positive, which explains why USDJPY barely budged on the heels of the release.
As we said in yesterday's note, retail sales needed to exceed 1.5% to save USDJPY from its current collapse. Even the drop in jobless claims from 346K to 334K failed to lift USDJPY because the meltdown in the Japanese yen crosses is just too strong.
See related: Yet Another USD/JPY Disaster
When Will the BoJ Cry Uncle?
The question now is when the Bank of Japan (BoJ) will cry uncle. On an absolute level, USDJPY 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, USDJPY and the Nikkei were "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 showed Japanese investors selling foreign bonds once again. With the Japanese continuing to repatriate their funds, their actions are driving USDJPY lower, not higher.
Stocks have also peaked in Japan, and US bond yields are lower, all of which contribute to USDJPY losses. So while Abenomics is supposed to be positive for USDJPY, so far, we have not seen its expected effects on Japanese investments, Japanese government bonds (JGBs), and the Nikkei, all of which are critical factors that contribute to the trend in USDJPY.
With today's move, USDJPY has fallen more than 8% from its May 22 high, so how much additional losses are needed before the BoJ gives in and either verbally or physically intervenes to drive down the yen?
Based on the percentage move and how quickly it has occurred, the BoJ should at least be trying to talk down the currency. However, policymakers have only defended the Bank’s non-action, and part of the reasoning may be last week's CFTC data, which showed speculators are net short and not net long the yen.
The BoJ is a street-smart central bank that likes to wait for short USDJPY positions to build up before verbally or physically intervening in order to get the most bang for their buck.
At 95, many investors may have abandoned their long USDJPY 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 stubborn overconfidence about the current policies could be clouding their good judgment.
By Kathy Lien of BK Asset Management