Yen Bull Eyes ¥105

by: Dean Popplewell

By Dean Popplewell

Wednesday April 6: Five things the markets are talking about

Yesterday, global equities came under renewed pressure with investors having a plethora of reasons to choose from, ranging from an overbought stock market, suspect earnings reports, weakening oil prices, U.S. Treasury department stunning the Street with new inversion rules, weaker German factory orders, a strengthening yen and an IMF Chief insisting that more government action is required to combat global “sluggishness.”

Nevertheless, today the market will want to be taking its cue from the Federal Open Market Committee (FOMC) minutes. The fixed income market will be hoping to get a better idea on the timing of the next Fed rate hike while the rest of us want a clearer understanding of what prompted the Fed to reduce the number of forecasted “dot plot” rate hikes this year from 4 to 2 in a matter of months.

1. Japanese officials clash over state of economy

With a matter weeks to go to the expected decision on the second round of a consumption tax hike, Japan’s government continues to debate just how bad domestic current conditions are to justify postponing the increase.

Last week, PM Abe indicated that his government would raise the tax rate “unless there is a Lehman-type event.” Overnight, opposition speakers suggest that current consumption is at its “worst level since the Lehman crisis.”

The rest of the market continues to focus on the strength of the yen (outright, trading atop its November 2014 highs ¥110.34) and wondering how aggressive the BoJ is expected to be?

The market has been record short yen futures and the latest dollar move has many speculating some form of intervention by the government or BoJ. Technical analysts have eyed ¥110 as that breaking point.

However, according to Mr. “Yen,” former Minister of Finance Eisuke Sakakibara (was in charge of currency intervention), he remains more bullish on his own currency, seeing it rallying to ¥105 in H2 as the outlook for the world economy worsens. He said that “a climb to ¥105 only then is likely to prompt Japanese officials to intervene verbally to try and talk it down, while gains past ¥100 could see physical intervention to weaken it.”

2. Global yields plummet as flight to quality dominates

Rising demand for haven assets yesterday again pushed down government debt yields.

The German Bund fell to their lowest yield level in a year, trading atop of zero interest (+0.09%). U.S. 10's reached their weakest return in two months at +1.72%, while the U.K. gilt benchmark 10-year yielded +1.34%.

Downbeat German factory orders coupled with U.K.’s Brexit referendum concerns has investors seeking sanctuary in the ‘big’ dollar and like-minded stateside assets. Other safe haven instruments, particularly gold ($1,226) and yen (¥110.34), have also found favor with investors who are trying to preserve capital.

Government bond yields have naturally fallen sharply this year as investors continue to struggle with a world of low growth, subdued inflation, falling productivity and a high level of debt globally. The ECB and BoJ have already generated a growing pool of negative-yield government bonds, intensifying investors’ struggle to obtain income (JGB’s continue to trade below zero). Even the Fed’s cautious stance towards rate normalization has reduced the risk of U.S. bond yields backing up aggressively any time soon.

3. Inversion rules stun Wall Street

The U.S. Treasury implemented tough new rules in Q4 to curb inversion deals – a U.S. company ‘reincorporates’ overseas following the purchase of a foreign company in an attempt to benefit from lower overseas tax rates.

This week, the U.S. Treasury has released another set of regulations aimed at “tax inversions” that look to prevent foreign companies from acquiring multiple U.S. companies over a short period of time. The new rules suggest there now will be a three-year limit on foreign companies acquiring U.S. assets to avoid ownership requirements for a later inversions deal.

Yesterday’s announcement has managed to scuttle the world’s largest ever healthcare acquisition – U.S. pharma giant Pfizer's (NYSE:PFE) $160b agreement to acquire +59% of Irish firm Allergan (NYSE:AGN) in an inversion deal. The deal would have given the New York-based company a foreign address and a lower tax rate.

The breakup of the deal will cost Pfizer a supposed cool +$400m!

4. Equities suspend slide on oil inventory surprise

A rebound in world crude prices overnight (WTI $37.03, Brent $38.79) is helping to slow down this month's global equity slide. Energy markets remain cautious after yesterday’s API inventories recorded the first draw down (-4.3m vs. +2.6m prior) in nearly two months. Also aiding oil prices is Ecuador’s President indicating that Latin America oil producers will meet on April 8th to discuss an oil output freeze.

To date, crude bulls have been focusing most of their attention on the April 17 Doha production meeting. Kuwait continues to express their confidence that global producers may agree to limit crude output and this despite tensions between Iran and Saudi Arabia.

Data on U.S. oil stocks will be closely watched this morning – Official EIA data is due at 10:30 EDT.

5. Federal Open Market Committee minutes

The release of the March FOMC minutes at 02.00pm EDT today could renew pressure on the ‘mighty’ dollar. The market is hoping to get a better idea on U.S. rate normalization timing – last week, investors were sideswiped by Fed Chair’s Yellen’s overtly ‘dovish’ comments.

Expect fixed income dealers to be seeking out the comments from Fed Kansas City President Esther George – she was the only dissenter on the vote to hold interest rates unchanged.

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