Capital Spending ex Software (2Q) (19:50 ET; 23:50 GMT)
Expected: 10.3%
Previous: 14.2%

Labor Cash Earnings (YoY) (JUL) (21:30 ET; 01:30 GMT)
Expected: -0.5%
Previous: -0.9%

How Will The Markets React?

Japanese capital spending growth is anticipated to slow down to an annual rate of 10.3 percent in Q2 – the weakest pace since Q4 2005 – signaling that businesses are not investing as heavily as they anticipate softer demand amidst an economic slowdown in the US. Nevertheless, even a drop in line with estimates still leaves the figure at relatively robust levels as capital spending remains a driver of Japanese expansion. In fact, the Q2 GDP report showed that capital investment climbed 1.2 percent, accelerating from a 0.3 percent gain in Q1. What about the consumer? That has been a far less resilient sector of the economy, as spending only rose 0.4 percent in Q2, half the pace of Q1. The current quarter isn’t likely to show a marked improvement either, as tepid wage growth limits disposable income. Indeed, labor cash earnings for the month of July are anticipated to show contracting payroll growth for the eight consecutive month, with estimates pinned at an annual rate of -0.5 percent. Given these deteriorating conditions, there is an increased burden on exporters and manufacturers to support Japanese expansion. Furthermore, it also limits the ability of the Bank of Japan to normalize interest rates, as declining wages and softer spending will do little to fuel inflationary pressures, as the economy remains in slight deflation.

Bonds – 10-Year Japanese Government Bond Futures

The Tokyo afternoon session gapped down sharply pm Friday, possibly leaving a runaway gap that suggests a bias reversal, especially as the daily charts show a reverse flag formation. Support at 135.00 has been holding up for the past week, but JGBs could plummet if Japanese economic data proves to be stronger than expected, as traders ramp up speculation of a September rate hike by the Bank of Japan. A bearish move lower could target 134.44, with sharper declines targeting 133.81.

FX – USD/JPY

The Japanese yen has appreciated quite a bit over the past two months, as risk aversion has pervaded the forex markets and led carry trades to unwind. Fundamental data hasn’t played much of a role in this, however, as Japanese expansion showed a sharp slowdown in Q2 and data continues to signal that the economy has yet to emerge from deflation. As it stands, there are really only two fundamental events that could perpetuate a strong move by the Japanese yen: a rate hike by the Bank of Japan or a jump in inflation – neither of which we’ll see this week. Nevertheless, traders should be aware of the Japanese economic data on tap this week, as the results could have an impact on future policy decisions by the BOJ. Capital spending is anticipated to remain strong, but show a slowdown from the quarter prior, while wage growth is predicted to soften further, which will not bode well for consumer spending. With two drivers of economic growth – business investment and consumption – showing diminishing power, the picture does not look good for Japan. Regardless, USDJPY price action will likely remain contingent upon risk aversion trends, and now that Fed Chairman Ben Bernanke has somewhat assured investors that he will support the markets in times of distress, carry trades and equities could resume their gains next week, with a break above trendline resistance at 116.93 targeting 119.34.

Equities – Nikkei 225

As traders became more risk-seeking at the end of the week, the Nikkei 225 broke through trendline resistance to end the session up 2.57 percent at 16,569.09. Japanese economic data has generally not played much of a role in Nikkei 225 trading, and next week isn’t likely to represent a shift from the norm. Capital spending is anticipated to remain strong, but show a slowdown from the quarter prior, while wage growth is predicted to soften further, which will not bode well for consumer spending. With two drivers of economic growth – business investment and consumption – showing diminishing power, the picture does look good for Japan. Similar to USDJPY trading, Nikkei 225 price action will likely remain contingent upon risk aversion trends. Now that Fed Chairman Ben Bernanke has somewhat assured investors that he will support the markets in times of distress, carry trades and equities could resume their gains next week, with the Nikkei 225 possibly targeting the 200 SMA at 17,275.

Terri Belkas is a Currency Strategist at FXCM.