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The dismal trade data out of Japan has weighed heavily on the JPY today, which is the worst performer in the G10. Exports fell 10.3%, the market had expected a fall of 9.9%,  which pushed the seasonally adjusted trade balance to JPY 980.3bn in September, from JPY461.9bn in August. This is the worst adjusted trade report since the 1990’s. This has fuelled a broad-based yen sell off this morning and USDJPY has surged through the 200-day sma at 79.40. It is now on track to test key resistance at 80.10.

China disrupts Japanese growth

Since exports and trade are such an important part of Japan’s economy the dismal September data could weigh heavily on growth in Q3 and into Q4. This has increased speculation that the BOJ may intervene in the market in a big way to try and weaken the currency and help boost the competitiveness of Japanese exports. The last time the central bank embarked on aggressive QE in February this year USDJPY rose from 76.00 to 84.00 in approx. 4 weeks. But the BOJ may be less willing to expand its balance sheet to try and boost growth this time round. The reason is that the bitter island dispute between China and Japan that kicked off last month is one of the main reasons for the sharp decline in Japan’s exports as Japanese factories in China had to close and consumers boycotted Japanese products as the tensions rose. The political dispute with China and the on-going Eurozone sovereign debt crisis is a toxic mix for the Japanese export market as these two economies are Japan’s largest trading partners.

The problem for the BOJ is that its action will only have a very limited effect on making foreigners buy Japanese products. The BOJ can’t heal the rift with China and make people in Beijing or Shanghai buy Toyota cars or Uniqlo clothing (two of the companies’ impact by the strife). Likewise, it is up to the powers that be in Brussels to sort out the Eurozone sovereign debt crisis, and in an era of deleveraging a weaker yen may not be enough to boost sales of Japanese exports to the currency bloc. Thus, unless we see a serious adjustment in policy in Japan then we may not see USDJPY regain those 84.00 highs from earlier this year. This pair is already looking overbought in the near term so we could experience some stickiness around the pivotal 80.00 level. Support lies at 79.40 then at 76.80 – the top of the daily Ichimoku cloud. See chart below.

A silver lining for Rajoy

There has been a dearth of economic data out of Europe and the US today so it has been left to Spanish regional elections and also Australian RBA rhetoric to fill the gaps. Spain seems no closer to a bailout after regional elections on Sunday. PM Rajoy won his home state of Galicia, while the nationalists did well in the Basque country and they are likely to continue their roll during elections in Catalonia next month.  While the surge in nationalism could make it harder for Rajoy to sign up for a line of credit or a bailout if it required more austerity, there was a silver lining. Although the voters in the Basque region don’t like Rajoy much, the dislike the Socialist opposition even more, which helps to solidify Rajoy’s position in central government. Since these elections were poised to be a confidence vote in Rajoy’s government, things could have been a lot worse.

Why the OMT needs to be activated

This is the seventh consecutive week without the activation of the OMT but this doesn’t seem to bother investors. Although Spanish bond yields are slightly higher today at 5.42%, they remain well below the 7% line in the sand. The question people are now asking is does the ECB need to activate the OMT programme? It seems unlikely Spain will make an aid request before  elections in Catalonia in 4 weeks’ time, but this doesn’t seem to be panicking the market, so there could be another few weeks’ of respite. However, we agree with a leading Spanish think tank that said today Rajoy should apply for a line of credit sooner rather than later due to the heightened risks of Madrid missing its fiscal targets for 2012 and 2013, which could spook investors and cause disruption in the bond markets.

US problems eclipse the currency bloc

For now the Eurozone crisis could slip down the scale of importance as we lead up to the US Presidential election on 6th November. The final Presidential debate takes place tonight and the polls put Obama and Romney neck and neck. This heightens the uncertainty about the outcome and increases the prospect of the US falling off the cliff edge at the start of 2013 if political deadlock ensues post the election next month. While volatility remains fairly subdued, the fiscal cliff and problems in the US could spark the next bout of volatility. Interestingly, although volatility remains low assets like the S&P 500, oil, gold and even some FX crosses have run into stiff resistance in recent weeks, which could suggest a weakening of bullish sentiment. I will be watching the gold price closely in the coming days and weeks. It rallied during the summer on the back of central bank action that has kept volatility levels depressed. However, if central banks’ actions remain mute (ECB) or ineffective (Federal Reserve) then we could see gold longs start to be unwound. $1,680 then $1,650 should act as solid support levels. But a sell off in gold could lead to a broader market sell off, so it is worth watching the yellow metal.

The end of the mining bonanza hurts AUD

In Australia, some dovish RBA rhetoric combined with fears that tough budget deficit targets for this year may not be met caused AUDUSD to sell off. However, it found support around 1.0320 – a cluster of daily smas. In the next couple of days the direction of this pair will be determined by the FOMC meeting that concludes on Wednesday.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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