Japanese GDP (QoQ) (2Q F) (19:50 ET; 23:50 GMT)
Expected: -0.2%
Previous: 0.1%

Japanese GDP (YoY) (2Q F) (19:50 ET; 23:50 GMT)
Expected: -0.7%
Previous: 0.5%

How Will The Markets React?

Normally, final readings of GDP don’t tend to garner too much attention, as initial and secondary estimates tend to pinpoint the figure relatively accurately. However, the story will be quite different for Japan as Q2 GDP is anticipated to be revised down to an annualized rate of -0.7 percent, reflecting contraction in the economy for the first time in two and a half years. The reason? Capital spending during the second quarter unexpectedly dropped at a rate of 4.9 percent after rocketing 13.6 percent higher during the previous period. The losses were generally contained to the previously-resilient services sector, putting an increased burden on exporters and manufacturers to support Japanese expansion. Unfortunately, these sectors may start to be threatened as well, as a marked slowdown in the US could lead demand to wane. The Bank of Japan typically refers to two factors when it comes to raising interest rates: stable growth outlooks or inflation. Clearly, the growth factor isn’t likely to support a rate increase, and with declining wages and softer spending doing little to fuel price pressures, the threat of deflation will probably force the central bank to leave rates steady.

Bonds – 10-Year Japanese Government Bond Futures

JGBs continue to hold within a down trending channel, though price closed just below resistance at the major intraday tops at 135.98/136.00. If JGBs hold below these levels, traders may see a move down towards support near 135.25. However, there is major event risk on the horizon as Q2 GDP is anticipated to be revised all the way down to an annualized rate of -0.7 percent. With the economy clearly still quite feeble and teetering on the edge of deflation, the Bank of Japan will have little room to hike, and the sentiment could send JGBs spiking above 136.00.

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. The news is only expected to get worse, as Q2 GDP is anticipated to be revised even lower to reflect contraction from last year as a result of an unexpected plunge in capital spending. With two drivers of economic growth – business investment and consumption – showing diminishing power, the picture does not look good for Japan. Regardless, USD/JPY price action will likely remain contingent upon risk aversion trends, and if the Federal Reserve somehow assures investors that they will support the markets in times of distress, carry trades and equities could resume their gains. Friday’s USD/JPY decline has stalled at the 100 percent extension of 117.12-113.86/116.61 at 113.34, and when traders re-enter the markets in the next Asian trading session, the consolidation underway now could lead to a thrust above 113.63 and possibly 114.09 before selling pressure returns.

Equities – Nikkei 225

As traders became more risk seeking at the end of last week, the Nikkei 225 broke through trendline resistance. However, this level has now become support, leading the index to trade within an uptrending channel. 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. GDP for the second quarter is anticipated to be revised sharply lower on the back of unexpectedly weak capital spending. With two drivers of economic growth – business investment and consumption – showing diminishing power, the picture does look good for Japan. Similar to USD/JPY trading, Nikkei 225 price action will likely remain contingent upon risk aversion trends. However, after Wall St. took a strong hit on Friday amidst dour US data, Asian session traders could take the Nikkei lower as well to target trendline support at 16,000.

Terri Belkas is a Currency Strategist at FXCM.