BoJ Has To Leverage Stimulus Or Face Yen Reversal

Despite the constant expansion of the Fed’s balance sheet and a fresh record high from the risky benchmark S&P 500, the dollar managed to close the week in the green. This was a ‘passive’ advance, however, just as the equities move was founded on a deficient fundamental backing – which was manifest in the tepid volume levels. Yet, where traders had to scrounge for a driver the past week, the greenback will be overwhelmed for catalysts moving forward. And, considering the positioning of the greenback against its most liquid counterparts, a dedicated driver is needed. From the Dow Jones FXCM Dollar Index, the 10,463 close on Friday marks the sixth consecutive monthly advance for the benchmark -- the longest run on record. We see this same strength in EUR/USD’s 6.5 percent rally the past two months, GBP/USD’s nearly 10 percent tumble since the year open and USD/JPY’s 25 percent rally in the past six months.

After an exceptional run to multi-month highs, the stress for a correction will be high -- especially if risk positioning continues to climb and slowly leach capital from U.S. assets that are undercut by yields that have been dehydrated by stimulus. Looking ahead, the most recognizable catalyst is Friday’s nonfarm payrolls (NFPS). The February employment figures are indeed important as they will eventually turn the tide on QE3. Yet, this end-of-week release is less pressing after the past week’s FOMC hold. The market will judge the dollar on its stimulus, but they will do so by way of comparison to other central banks’ efforts. The Bank of Japan (BoJ), Bank of England (BoE) and European Central Bank (ECB) are all looking at some degree of possible balance sheet expansion. Can they offset the Fed and leverage the dollar?

Japanese Yen: BoJ Has To Leverage Stimulus Or Face Yen Reversal
In the flood of event risk this coming week, the BoJ rate decision on Thursday morning carries the greatest potential for generating volatility and consistent trend. It also arguably carries the most clearly defined scenarios for traders to work with. Ever since Shinzo Abe began his run to the Prime Minister seat on the vow of ending deflation and stabilizing the economy, expectations of extraordinary and external support has soared. At this point, expectations have far outpaced actual policy -- a realization that has seen USD/JPY and other yen crosses level off over the past few months. The fact that the yen hasn’t extended its aggressive decline over the past two months despite the change of leadership at the BoJ and the vague vows made by new Governor Kuroda and his Deputy Governors tells us that the bar is set very high.

For the past five years as global central banks have expanded their stimulus programs in order to fend off liquidity crises, financial disarray and recession; we have seen a strong, inverse correlation between the size of the support program and the currency’s strength. This connection is what makes the yen’s fundamental discrepancy so evident. USD/JPY rallied as much as another 12 percent since the beginning of the year even as the Fed bought $85 billion in assets a month and the BoJ held steady. If the central bank does not at least move forward its ¥13 trillion-per-month program to May as bulls’ expectation, the yen crosses could be set for an abrupt correction.

British Pound Ready To Run If Bank Of England Holds Steady
The sterling-BoE fundamental scheme is like a scaled down version of the yen-BoJ setup. Since the beginning of the year, GBP/USD has tumbled over 1,300 pips from 1.6400 on the growing expectation that the Monetary Policy Committee (MPC) will ramp up its stimulus program to compete with the Fed’s QE 3-laden and ECB’s LTRO-padded regimes. There is certainly argument to be made with Marc Carney coming onboard in July and Chancellor Osborne recently offering a remit (greater allowances to deviate from CPI), but this may just be community stimulus expectation. There was no change to the vote in the minutes at the last meeting. What if the BoE is mum despite its allowances…

Euro Crisis Shifts To Italy, Slovenia, ECB And Systemic Issues
Cyprus can still cause problems for the broader euro zone, but the imminent risk is far reduced from where has been over the past two weeks. However, that doesn’t mean the Euro is looking at an immediate return to bullish form. Systemic fears have been stirred and there are new threats within view. Greece and Spain are lingering threats under the new ‘bank levy’ option (which investors will try to escape at any sign of risk), but we also have more active threats. We’ll find a financial outlook for Slovenia and Italy will have to decide a government path next week.

Australian Dollar At The End Of Its Rate-Cut Regime, RBA on Tap
There are four major central bank rate decisions scheduled for the coming week; and the Reserve Bank of Australia’s (RBA) meeting carries the least, short-term market moving potential. Yet, it will still be critical for shaping the Aussie dollar’s bearings. In the past six months, we have seen the 12-month rate forecast price in nearly 5, 25 bp rate cuts to serious debate over whether there will be even one. The language from Governor Stevens and crew hasn’t shifted much. But given the market’s bearings; if he were to shift, it would make the currency a resilient carry option.

Canadian Dollar Gaining Central Bank Favor, Ready for Jobs Volatility
Last year the IMF noted that it was examining whether the Canadian (and Aussie) dollar would be giving the distinction of ‘reserve currency’. This potential honor comes as central banks increase their holdings of the loonie, and the IMF’s quarterly report shows that share continues to grow. Meanwhile, volatility traders will be watching the March employment figures Friday. But, beware of the cross influence from U.S. data.