Japanese shares cheer Abe’s victory, as focus turns to ECB

The big political story of the weekend was the Japanese general election result. Incumbent Shinzo Abe, who called the snap election, managed to pull off something Theresa May could not do in the UK, he maintained the ruling coalition’s two-thirds majority in the lower houses of Parliament. We look at the market impact.

The big political story of the weekend was the Japanese general election result. Incumbent Shinzo Abe, who called the snap election, managed to pull off something Theresa May could not do in the UK, he maintained the ruling coalition’s two-thirds majority in the lower houses of Parliament. This could help him to become the longest reigning Prime Minister in Japanese history, as it increases his chances of being nominated for another term as leader of the Liberal Democrats next year.

Good news is bad news for the yen

The markets have rejoiced at the political certainty, the Nikkei closed up more than 1%, extending its recent rally and making a fresh 21 year high, the last time the Nikkei was above 21,000 was in 1996. Likewise, the Topix also broke out of its recent range, rising to its highest level since 2007. The quirkiness of the yen means that it has fallen sharply on the back of the election result. The yen’s ingrained safe haven status means that good news can be bad news for the Japanese currency, and USD/JPY is down some 0.3% since the election result. As you can see in chart 1 below, the inverse correlation between the yen and Japanese stocks is well entrenched, so a weak yen is part of the reason for the strong performance of Japanese stocks at the start of this week. The other driver of stocks has been the political outcome itself. With Abe as PM it makes it more likely that the BOJ’s Kuroda will win another term as governor, this makes the BOJ’s stimulus programme likely to be maintained, so markets are also cheery the certainty of future liquidity as a consequence of this election result. Overall, there could be further upside for Japanese stocks as traders price in the prospect of political certainty + central bank liquidity, both powerful drivers of equities right now.

Why the Catalan crisis is only having a muted impact on financial markets

The media is focusing on the Catalan response to Madrid’s statement at the end of last week that it would take away the region’s autonomous status as a result of Catalonia’s declaration of independence. This may be the focus of news articles, but it is not having a major impact on financial markets just yet. As we have mentioned, financial markets move on solid news, however, the Spain/ Catalonian spat is a complicated process that has layers of legal and political complexity that could take years to resolve. The Ibex is down some 0.4% today, bucking the overall upswing for European indices, however, the Ibex has been falling since peaking in May, and recent declines looks more like a continuation of an established down trend rather than a market panic. Interestingly, the bond market has barely reacted to this event, the Spanish – German yield spread is only 1.19%, below the Portuguese – German yield spread at 1.85%. Until we see a sharp increase in the Spanish bond yield, we believe that markets will turn a blind eye to political events in Spain. Unless Catalonia’s quest for independence threatens the economy in a serious way, then we would expect a strong reaction to be felt in the bond market first.

Why the path could be lower for the euro

The euro is lower today, however, the 0.3% drop vs. the USD suggests that even if the decline is all down to Catalonia, FX traders are not in panic mode yet even though the Lombardi region of Italy and Sicily are also demanding more autonomy from Rome. The FX market’s focus is likely to shift to the ECB, who hold a critical meeting this Thursday. The market is expecting an update on the ECB’s Asset Purchase Programme, the APP, and news of a taper. Draghi will, as usual, have to perform a balancing act this week: placating the hawks who want to see an end in sight for QE, and the doves who don’t want the liquidity taps turned off too quickly. Overall, we expect the ECB to agree to a slowdown in asset purchases from EUR 60bn per month to EUR 20-30bn. The market reaction is likely to be binary: anything more aggressive than this could see the euro rise, anything slower than this rate of tapering could see the euro fall. Since the euro is towards the bottom of its recent range, the path of least resistance at the moment seems to be further weakness, so we may see back to $1.1660 – the 100-day sma, as we lead up to Thursday’s meeting.

Chart 1: 

Source: City Index and Bloomberg 

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