Traders cast votes ahead of Japanese election

Markets are now starting to price in an almost certain victory for Japan’s Liberal Democratic Party (LDP) when elections are held over the next few days. LDP leader Abe is expected to follow through on his campaign promise of injecting a huge amount of stimulus into the Japanese economy – flooding it with yen. The target is to see inflation at 2-3% but the means of achieving that carries with it big risks. Japan’s government balance sheet is already stretched, yields are at very low historical levels and if the experiment doesn’t work out – higher debt and continuing anemic growth – then markets will slowly start to price in a much worse scenario.

The plan is risky because the government’s pledge to spend around 200 trillion yen in public works represents around 40% of the country’s economic output. Japan’s balance sheet is not without strain either. Total government outstanding debt currently sits at around US$11.7 trillion compared to GDP of around US$5.4 trillion. This is not a net number which somewhat can improve the metrics. Most of Japan’s public debt is financed by domestic investors, which helps mitigate problems such as the European debt crisis we saw in 2012 for example.   Japan also has an ageing population and the public balance sheet needs to be addressed as the demographics start shifting.

RBA – out of the office

Most traders are watching the USDJPY but we’re keeping a closer eye on the AUDJPY and the consequences of a firm appreciation above the 90 level which we haven’t seen in a while now. Australia’s Reserve Bank is on holiday until early February and so there remains a reasonably large window of time between ongoing yen weakness post Abe’s win and RBA moving to cut rates and contain AUD appreciation in February. A convincing break above 90 could see much higher levels tested, the AUD has a reasonably firm ceiling against the USD near 1.10 levels but the JPY is far from levels the BOJ sees reasonable. Should the USDJPY trend towards 100 – where many ailing Japanese exporters feel comfortable – and the AUDUSD near 1.10 cap levels, then AUDJPY looks set to test out 90.90-91.00 range in the coming months.

Key levels – Escalating yen shorts against the USD in the Chicago Mercantile Exchange show the highest negative positioning in the currency since the June 2007. A move above 84 on the USDJPY could see a flood of trades entering the market. The AUD is fast becoming a global currency of choice and with the Reserve Bank on holiday until February; room for appreciation is fairly larger. A break above 88.00 in the coming hours could see the AUDJPY hold those levels and consolidate; a reversal could see the gap filled all the way back to 86.20-86.36 where we see solid support.