Yen Hurts Ahead of Another Regime Change

Japanese PM Noda’s indications that he could dissolve the House of Representatives on Friday if the opposition agreed to plans to reduce the number of seats and to lower lawmakers’ salaries weighed on the yen across the board. The dissolution would lead to elections that are widely expected to end the Democratic Party’s three years in power.

The implications of seeing the Liberal Democratic Party (LDP) back in power mean that its leader Shinzo Abe would further exert his influence on the Bank of Japan to step up its activism in battling inflation by way of more extensive asset purchases. Such yen-negative prospects would be magnified by prolonged concerns with lack of medium term fiscal consolidation.

Political disarray and looming escalation in asset purchases are seen compounding recent yen losses following the latest figures showing Japan’s 0.9% GDP contraction in Q3 could well drag the country closer to its fifth recession in 15 years.

Aussie is seen as accumulating the greater potential for accumulated upside vs. the yen relative to USD/JPY, EUR/JPY or CAD/JPY. Despite the current sell-off in global equities and the positive correlation between AUD/JPY and world equity indices, the Aussie has outperformed most currencies over the past six months and four weeks on reduced prospects for further easing by the RBA and stabilising dynamics in China.

Considering the high profile leadership transition in China, and the prevailing easing policies (via low-profile open market operations rather than high profile cuts in interest rates), a gradual stabilisation in China would undo the Aussie risk premium associated with a China hard landing.

AUD/JPY broke above all key weekly moving averages (55, 100 and 200) over the past six weeks, eyeing the 85.00 territory. A successful breakout would lead the way for 87.00 as the momentum dynamics revealing similar forces to those in April-May of this year.

USD/JPY may be nearing eight-month highs, but the lingering uncertainty from fiscal cliff resolution and prospects for more aggressive policy steps from the Fed continue impose a lingering US dollar risk. Owing to these dynamics and the forces capping US bond yields, USD/JPY is seen contained at 81.70.