Ahead Of The BoJ: All Eyes On USD/JPY

Tonight is a big night for USD/JPY. Aside from the Bank of Japan's monetary policy announcement, BoJ Governor Kuroda is speaking, consumer prices are scheduled for release and the central bank will be releasing its semi-annual outlook for the economy. Last night's weekly portfolio data from the Ministry of Finance failed to drive USD/JPY above 100 because Japanese investors continued to sell foreign bonds. Despite the broadly held belief that Bank of Japan easing will force investors to go global, we have seen zero evidence of an increase in foreign bond purchases since the April-4 decision. Yet the sell-off in USD/JPY was limited because tonight's economic data and events pose an upside risk for the currency pair if the BoJ feels that the market did not get their message the first time around and decides to clarify, harden or increase their conviction to ease monetary policy aggressively until consumer price growth reaches 2%. Considering that national CPI is currently running at a rate of negative 0.7% and is expected to drop further to -0.8% on lower commodity prices, the BoJ has a long way to go and could therefore be more vocal in their monetary policy statement, Kuroda's speech or semi-annual outlook with the goal of boosting inflation expectations.

What could the BoJ do? The central bank is not expected to increase stimulus but they will be releasing their GDP and inflation forecasts. In the past, the outlook report only contained forecasts for the current and coming year but it is expected that the semi-annual outlook report could contain forecasts going out to 2015. What we will be looking for are the BoJ estimates on when 2% inflation will be achieved and the sooner they expect it to occur, the more aggressively they will need to ease. Given recent improvements in economic data, the BoJ could also upgrade its GDP forecasts but don't expect this to help the Yen as the central bank will also confirm their unquestionable commitment to achieving their inflation target.

Will this be enough to drive USD/JPY above 100? Quite honestly it is hard to tell. If the BoJ simply expands their inflation forecasts and boosts their GDP forecasts, it may not be enough unless they feel that they can boost CPI to 2% in much less time than two years. If central bank Governor Kuroda sets expectations for additional easing in the months to come, that could be enough to drive USD/JPY above 100 -- but there is no question that this is a formidable barrier that can only truly be broken when Japanese investors start to buy foreign bonds in size.

USD: Lofty Expectations For Q1 GDP
The U.S. dollar traded lower against all of the major currencies despite a solid weekly jobless claims report. Initial claims dropped to a six-week low of 339K, down from a prior report of 355K. Continuing claims also fell from 3.093 million to 3 million and together they indicate that U.S. companies are growing more confident and therefore laying off fewer workers. Now the question has been job growth and not job losses so the real test will be next week's non-farm payrolls report. On balance, claims in April have been lower than claims in March and should bode well for next week's release. Currently economists are looking for payrolls to rise from 88K to 155K, but this could change as we are still a week away from the release. U.S. first quarter GDP numbers are due for release tomorrow and economists are looking for a huge increase in growth. In the fourth quarter, the economy expanded by only 0.4% but in the first quarter, growth is expected to hit 3%. A large part of the growth is expected to come from inventories and personal consumption -- the rise in inventories represents a rebound after droughts at the end of last year caused a pullback in farm inventories. However with retail sales and trade numbers weakening from Q4 to Q1, we are skeptical about the strength of U.S. GDP growth in the first three months of 2013. Three percent growth will be hard to beat and if the GDP surprises to the downside, it could cap the rally in USD/JPY.

EUR: Driven Lower By Rate Cut Calls
It has been an extremely volatile trading day for the euro which started the North American trading session strong thanks to the news that Enrico Lette was named Prime Minister of Italy and tasked with the job of forming a new government but ended it weak. Stronger than expected U.S. jobless claims capped the rally in the euro and the sell-off gained momentum after Goldman Sachs joined the chorus of banks calling for a rate cut by the European Central Bank next week. Between the weak German IFO report and PMI numbers, the ECB has good reasons to ease as economic weakness spreads to core euro-zone economies. No economic data was released from Germany today but France reported a record number of unemployed job seekers in March while Spain reported a record unemployment rate. Labor market conditions have deteriorated across the region and with commodity prices declining lower inflationary pressures could give the ECB more reason to cut rates. We already know that a number of policymakers are not adverse to the idea. Since the last meeting, we have heard a number of ECB members say that a rate cut is possible if data weakens and now that we have seen the deterioration, we can expect their support for easing in May. The ECB is a central bank that likes to prepare the market for potential changes in monetary policy and as such we would not be surprised to hear more dovish comments over the next week and if we do, it would harden the case for a rate cut. Yet with all of this in mind, we can't help but point out that the EUR/USD is still trading around 1.30, a level that has magnetized price action for the past week.

GBP: Triple-Dip Recession Avoided
The best performing currency today was the British pound which rose above 1.53 and 1.54 to hit a high just shy of 1.55 (1.5481 to be exact) on the back of stronger than anticipated GDP numbers. With the U.K. economy having doubled dipped into recession over the past year, the greatest fear yesterday was that the data would show the economy slipping into its third technical recession. Thanks to a 0.6% rise in service activity, the U.K. economy expanded by 0.3% in the first quarter according to the government's initial estimate. The Bank of England will certainly be relieved to see the country avoid the stigma of a triple-dip recession and the pressure that would have undoubtedly come upon them to ease. While the recent decline in commodity prices helped to lower prices pressures, the BoE's obsession with inflation still leaves them weary of increasing stimulus unless it is absolutely necessary. The case for additional Quantitative Easing still exists but certainly weakened with today's release. The BoE has previously warned not to make too much of the GDP report because it can be volatile but what the data is telling us unambiguously is that the despite all the troubles and concerns about U.K. growth, the economy is still growing.

CAD Soars On Positive Keystone Pipeline Developments
The Canadian, Australian and New Zealand dollars traded sharply higher against the greenback today following good news out of Canada. Average weekly earnings increased in the month of February, which is encouraging for the labor market and the outlook for spending, but the big story was the news that a second House Committee approved a bill that would allow construction of the Keystone Pipeline without the approval of President Obama. To be able to transport 830,000 barrels of oil per day through this pipeline would be a huge boom for Canada. There's still a long path here to final approval (the bill now goes to the chamber for vote) and concerns about its environmental impact could still block the pipeline from being built. Nonetheless, for now the progress is helping to drive the CAD higher. Meanwhile the New Zealand dollar has also performed well ahead of its trade balance report. While the RBNZ sounded optimistic earlier this week, a large decline in business PMI suggests that the data could surprise to the downside. The Australian dollar also traded higher but there were no economic reports on the calendar with no data expected this evening.

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