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Cautious investor sentiment may rock Abenomics

Currency pairing USD/JPY needs to break above 100.50 convincingly in order for the Nikkei to add to recent gains.

I wrote about the Nikkei back in early June, following a significant correction which saw declines of almost 23% in the face of Ben Bernanke’s initial taper tease. I predicted that we would see the Nikkei eventually bounce back, and, though I was spot on, it wasn’t that difficult to call given that most global indices have benefited from a continuing easy monetary policy from various central banks; most notably the US Federal Reserve.

Nevertheless, the gains seen in the past five months of around 24% are substantial and, as we anchor around the 15,000 level (ironically at the same time that global indices pay a visit to psychological round number metrics), one has to question if things can go even further from here.

It appears that a degree of caution has set in, with the market not quite finding the gas to move through the 15,300 level. Any prolonged move through this would set the Japanese index on a target to make a new stab at the highs last seen in May.

In a bid to target 2% inflation, the three-pronged Abenomics plan has worked to some extent. The promise of Shinzo Abe’s first arrow – the implementation of massive monetary expansion – could be said to have had a weakening effect on the yen more significantly than the actual act itself. The second arrow – investment in public works and renovation of old infrastructure – aims to create jobs and increase salaries.

It may be the third arrow of the plan that the markets have had difficulty getting to grips with – ‘deregulation and creation of sustainable growth’ sounds a little woolly. Japan's government has been encouraging regional investment in order to build ties and secure resources; foreign investment threatens to weaken the yen by boosting the exporters’ profits. Japanese companies socked away roughly $144 billion in cash between June 2012 and June this year according to the Bank of Japan, bringing its total cash pile to $2.24 trillion. Also worth noting, Japanese GDP dropped to 0.5% in Q3, as economic activity continues to contract in 2013. This may be another case of the fundamentals not correlating to the equity market’s extensive gains.

The breakouts witnessed in EUR/JPY and USD/JPY recently probably means that the Bank of Japan’s monetary decision on Thursday will again see heightened attention. Any hints of changes to the current monetary programme will see additional moves in these currency pairs, and therefore the Nikkei.

The USD/JPY currency pair has today found difficulty staying above the 100Y mark. Support is currently being found at the 99.65 level (the 76.4% retracement from the September highs of 100.60 to the lows of 96.56 in early October). Global equity markets are off their all-time highs and seem to be consolidating in advance of more Fed-speak. Gold is not benefiting from safe-haven play (yet), but investor caution and the flow to the yen as a result could well see the currency struggle to weaken.

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