BSI Lg Manufacturing (QoQ) (Q4) (23:50 GMT; 18:50 EST)
Expected: ---
Previous: 6.2

BSI Lg All Industry (QoQ) (Q4) (23:50 GMT; 18:50 EST)
Expected: ---
Previous: 7.7

What Are The Markets Facing?

Business sentiment in Japan is likely to falter in Q4 as a stronger yen hurts exporters and a global credit crunch increases borrowing costs and damages prospects for growth worldwide. Last quarter, the Business Sentiment Index for not only manufacturers, but all industries, proved to be optimistic as companies were confident that the economy would recover after contracting during Q2. This time around, however, the situation is quite different, and businesses are rightfully worried. In fact, the Bank of Japan’s Tankan index of manufacturer sentiment fell more than expected in Q4 to 19 from 23, and over the past two years, large shifts in the Tankan reading tend to coincide with movements in the BSI. The performance of businesses in Japan is of great concern to the BOJ, as the bank’s Governor, Toshihiko Fukui, said last week that he was concerned falling profits would hamper wage growth and put a dent consumer spending. Nevertheless, neither of these factors have shown sharp improvements in recent months, so if anything, the greater concern for Fukui may be that he will be prevented from pursuing further rate normalization before he leaves his post at the central bank early next year. Indeed, the most recent policy meeting resulted in a unanimous vote to leave rates steady, as even the sole hawk on the monetary policy board, Atsushi Mizuno, backed off in light of the tumultuous credit market conditions and its threat to the economies of the US, UK, and Europe. Furthermore, the BOJ has downgraded its assessments of the economy for the first time in three years, and with inflation showing few signs of building, the markets are actually starting to consider the potential for a rate cut before Fukui’s departure. As a result, a disappointing BSI release may only lead this speculation to be exacerbated amongst traders.

Bonds – 10-Year Japanese Government Bonds

Japanese government bonds have fallen back quite a bit since failing to push through resistance at 137.11, though declines have paused at trendline support at 136.40. Japanese economic data early next week could help give the contract a boost, as souring business confidence raises the risk the BOJ may actually cut in the near-term. On the other hand, additional gains in the Nikkei could weigh JGBs towards 136.10.

FX – USD/JPY

The Japanese yen has gradually weakened against the greenback through December, and the recent consolidation of USD/JPY within an ascending triangle creates the potential for a breakout to the upside. Furthermore, according to Technical Strategist Jamie Saettele’s Elliot Wave analysis, USDJPY is likely to rally towards 114, where falling trendline resistance sits (Join other traders in discussing Elliott Wave Theory on the DailyFX Forum). However, USD/JPY has had difficulty getting to that level, and low trading volumes ahead of the holidays have not helped the case. While the move higher could come on Friday, Japanese economic data due to be released early next week could spark a break higher in USD/JPY, with a solid rally targeting 114.77. The Business Sentiment Index is anticipated to reflect souring confidence in the fourth quarter, which may raise the risks that the Bank of Japan will cut rates. With interest rates already at an ultra-low 0.50 percent, the news will do little to support a bid tone for the yen from an interest-rate-differential perspective. On the other hand, with few traders in the markets next week, the news may simply go unheard, leaving USD/JPY to drift sideways.

Equities – Nikkei 225 Index

The Nikkei 225 Index has bounced from critical support at the psychologically important 15,000 level, as the softening yen boosted shares of exporters. If news flow remains thin next week, Japanese equities could benefit and push the Nikkei towards 15,500, but the release of the Business Sentiment Index could counter any gains. Indeed, BSI is likely to fall in line with the disappointing Tankan survey, which may raise fears that business will be less profitable.

Terri Belkas is a Currency Strategist at FXCM.