Two Developments Rattle FX Market

There are two main drivers in the foreign exchange market today: the much anticipated BoJ meeting and the much stronger than expected German ZEW survey.

Anticipation of aggressive easing by the BoJ today has kept the yen on the defensive. However, the combination of "sell the rumor and buy the fact" activity and, arguably, some disappointment, saw dollar turned back from the JPY90 level, which it has test during the three prior sessions without a convincing break and fall to near JPY88.35 before finding a bid. Similarly the euro, which had been flirting with the JPY120 area, was sold down to almost JPY117.30 before finding a solid bid.

The BoJ's announcement seems to be a compromise formation. It was reluctant to be as aggressive as the government wanted so it gave some appearances of kowtowing without actually doing so. For example, it embraced a 2% inflation goal, but does not believe it can be achieved any time soon. Look at the BoJ's inflation forecasts. It let the 2013 forecast unchanged from previous (Oct) forecast at 0.4% and the 2014 forecast was nudged higher to 0.9% from 0.8%. Two BoJ members, (Kinchi and Sato) dissented from the new inflation target.

In addition, the open-ended quantitative easing does not begin until the start of 2014, when the current asset purchase scheme expires. The BoJ intends to buy mostly bills, which in effect replace the bills that it is buying that will be expiring. This also seems to dilute the appearance of aggressiveness. Finance Minister Aso indicated that the government is not considering changing the BoJ Law at this juncture. A more aggressive central bank, that could cut interest on current deposit account at the BoJ and purchasing foreign bonds, for example, will likely await the new leadership that will likely be in place in the April-May period.

The second important development was the stronger than expected German ZEW survey. The sentiment reading jumped to 31.5 from 6.9. The Bloomberg consensus called for 12.0. This is a 2 1/2 year high. The assessment of the current situation also improved (7.1 from 5.7 and also better than the 6.2 expected). It is important because it lends credence to the BBK's optimism that after contracting in Q4 (by as much as 0.5% quarter-over-quarter) that the euro area's largest economy was already recovering. Attention now shifts to Thursday's flash PMI readings for further confirmation.

The euro had been approaching last week's low near $1.3260 on the back of rumors (denied by the BBK of Weidmann's resignation) and concern about German banks (rumors of a large loss) and an inquiry by the national regulator (Bafin) as to the effects of splitting the retail from investment function at a couple large banks. The DAX is still under performing, slipped 0.5% in the morning session, led by the financials and utilities.