Tokyo CPI Core (YoY) (OCT) (23:30 GMT; 19:30 ET)
Expected: -0.3%
Previous: -0.3%

Industrial Production (MoM) (SEP P) (23:50 GMT; 19:50 ET)
Expected: -1.1%
Previous: 3.5%

How Will The Markets React?

Japanese economic data will likely continue to signal that the Bank of Japan cannot make the case to raise rates before year-end. Indeed, Tokyo consumer price measures, excluding food and energy, are anticipated to show that deflation still reigns for the ninth consecutive month. Despite the tightness of the Japanese labor markets, wages have failed to rise and as a result, consumption growth has been extremely anemic. As a result, businesses simply do not have the ability to pass through any price increases to the consumer if they plan on actually selling anything. Nevertheless, Bank of Japan Governor Toshihiko Fukui remains optimistic and said recently that core prices will resume increasing “before long” and continue to rise “over the long term” after hovering around zero “for some time.” What about the other thorn in Japan’s side: fears that a slowdown in the US economy will lead export growth to drop. Thus far, producers appear to be faring well with the help of demand from Europe and the rest of Asia. However, the release of industrial output figures could make traders a bit more pessimistic as production is anticipated to have dropped 1.1 percent in September from the month prior. If this happens to be the case, the Bank of Japan may revise their forecasts for expansion throughout the rest of 2007 and early 2008 when they meet on October 30. Nevertheless, the potential impact of this news on the forex and equity markets is questionable, as USD/JPY and the Nikkei 225 have been driven more by risk aversion trends lately. However, if the data proves to be surprising, the news could shake carry trades and Japan’s stock market up.

Bonds – 10-Year Japanese Government Bond Futures

Support at the 136.00 level has propped JGBs higher and despite the narrow range, the contract could continue higher to test 136.25 once again, especially if Japanese data falls in line with expectations or if risk aversion jumps market-wide. However, a break below short-term trendline support could find JGBs easing towards 135.75.

FX – USD/JPY

The Japanese yen has been the main beneficiary of the buildup of risk-averse sentiment throughout the financial markets, which has also pushed equity indices like the DJIA and Nikkei 225 lower. However, USD/JPY recently hit trendline support just above the 113.00 level, but gains have been limited by a resistance trendline. With the pair getting squeezed, it’s only a matter of time before price breaks out. For USD/JPY to take on the August lows once again, a plunge in the equity markets would be the most likely trigger for the move. However, surprisingly strong Tokyo CPI or industrial production figures could serve as a strong spark as well, as the news would support the case for further rate normalization by the Bank of Japan. However, the data is expected to work in the favor of BOJ doves, as the economy probably remains in deflation while lackluster export demand from the US may have taken a toll on industrial output. As a result, USD/JPY may see brief gains following the data, but it will take a break above the 115.00 level to signal truly bullish action for the pair.

Equities – Nikkei 225 Index

The Nikkei 225 daily chart looks extremely similar to that of the USD/JPY, as the index recently bounced from trendline support at 16,250. If this level manages to hold up, the Nikkei should be in for gains in coming days. While Japanese CPI is unlikely to be a major market mover for the index, industrial production results for the month of September could halt potential rallies, as signs that softer US export demand is driving output lower will bode ill for manufacturers. However, if the data actually improves, the surprisingly positive news could lead the Nikkei to rise towards 16,750.

Terri Belkas is a Currency Strategist at FXCM.