Yen Gains Are Main Feature In Consolidative Tuesday

The larger capital markets are mostly calm. Asian equity markets were mostly lower, with the Nikkei's 0.85% pullback among the largest for the large markets. Loses were led by a 3% drop in financials, while the 1.1% gain in telecoms offered a partial offset.

European bourses are more mixed with the Dow Jones Stoxx 600 eking out a minor gain near midday in London. Of note, the financials are extending yesterday's gains, albeit marginally, following the weekend announcement of the relaxation of Basel capital requirements. Debt markets are mostly quiet, though Italian and Spanish bonds remain firm.

The dollar pushed above JPY88.00 before the weekend, but failed to sustain the momentum yesterday and finished the North American session near its lows. Follow-through selling took place in early Asia and took the greenback to almost JPY87.20. However, it quickly stabilized as buyers on the dip emerged. There are four developments to note.

First, Prime Minister Abe has indicated that Japan will buy ESM bonds with currency reserves, though no amounts were mentioned. He said this would support Europe and weaken the yen. Between July '11 and the end of last year, Japan appears to have purchased about 7 bln euro of EFSF bonds. For it to buy ESM bonds (it is selling bills today) is not surprising and does on the margin support Europe. For it to weaken the yen is a bit a of stretch. Japan holds mostly dollars and euros in reserves. It is not clear why the yen should be impacted if Japan shifts some of its dollar holdings into euros. Nor is there any foreign exchange impact if the BOJ simply swaps national European bonds (such as German bunds) for ESM bonds.

Second, there are reports suggesting that some investment managers are preparing to unwinds some Australian dollar Toshin funds due to targets being reached. At least initially this would be consistent with a stronger yen, but the Australian dollar itself is little changed around $1.05.

Third, Fitch has indicated that it will not change Japan's sovereign rating despite the stimulative fiscal policy the Abe government is pursuing (new stimulus measures in the form of an extra JPY12-JPY13 trillion budget, is expected to be unveiled before the weekend). Instead, Fitch seemed to suggest that iit does manage to spur great growth, it would be a supportive development.

Fourth, there are reports that the Japanese government and BOJ are hammering out an agreement under which the BOJ will add "stable job growth" to its economic goals. Apparently, such an agreement can bypass formally changing the BOJ's charter. There seems to be some tempering on the edges of the aggressive rhetoric of the new government.

Indeed, given that Australia reported its largest trade deficit in 4 1/2 years, by being little changed, the Aussie is faring well. The A$2.64 bln trade shortfall was about 10% larger than expected. Exports rose 1.2% while imports were up 1.8%. With iron ore prices recovering and the Chinese economy appearing to stabilize, the Australian trade balance may also begin consolidating. On Wednesday, Australia reports November retail sales. A 0.3-0.4% increase is expected after a flat reading in October The market is pricing in almost a 50% chance of a 25 bp rate cut next month.

Seemingly dovish minutes from Sweden's Riksbank are helping to fan expectations for another rate cut as early as next month. The krona was sold off, but the market may be getting ahead of itself. The minutes come from a meeting in which the Riksbank delivered a rate cut. The euro's bounce against the krona comes after the euro fell 3.4% from mid-Dec through last week. The downside momentum had already eased near SEK8.50, the lower end of its 3-month trading range. Look for euro gains to stall just above SEK8.60.

There are two developments in the US to note. First, reports suggest that Obama will soon announce Jack Lew, his Chief of Staff, will replace Geithner at the helm of the Treasury Dept. Clearly with debt ceiling debate and negotiations on the sequester (spending cuts associated with the fiscal cliff that were postponed for two months), the next Treasury Secretary will have to hit the ground running. Second, the Q4 earnings season begins in earnest today with Alcoa's (AA) report. The consensus looks for S&P 500 earnings to rise 2.4%-2.9% and only 0.2%-0.5% excluding financials.