Japan's 3-Ring Circus Opens As USD/JPY Breaks 110 - Analysis

In the weeks and months ahead, those keeping an eye on Japan and its currency will be treated to a three-ring circus, which started off Tuesday with a break in dollar-yen below the psychological Y110 level for the first time since October 31, 2014.

In April, May and June there is event risk from yen swings, Bank of Japan monetary policy and government stimulus action, analysts said.

In the case of FX, today's sharp move lower in dollar-yen, below various key supports, has yen traders debating how the Ministry of Finance and Bank of Japan may response if the pair sees a sustained move below Y110.

Dollar-yen held at Y110.46 Tuesday afternoon, in the middle of a Y109.95 to Y111.36 range.

In addition to increased risk aversion that has seen safe-haven yen demand, the pair has been under pressure due to falling U.S. Treasury yields. Ten-year yields have moved from 2.0% on March 16, ahead of the Fed decision to a low near 1.717% today, nearly back at March 1 lows near 1.704%.

The earlier quick dip below Y110.00 earlier, in late U.S. morning action, and subsequent fast-paced bounce to Y110.44, echoed the trading action seen March 17, albeit on a smaller scale.

That day in mid March, dollar-yen broke below what was then double-bottom support near Y111.00, saw a quick dip to Y110.67, the lowest levels since Oct 31, 2014, and then a fast-paced 100 pip-plus rally afterwards on talk of the BOJ "checking rates" in early U.S. action.

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Dollar-yen will need to see a clear-cut close above Tuesday's high, well above old supports now resistance at Y111.00, before the market becomes less bullish toward the yen.

Already Tuesday, there were clucking sounds from BOJ officials about the yen gains seen ahead of the U.S. open.

Osamu Takashima, G-10 strategist at CitiFX, downplayed comments made overnight by Chief Cabinet Secretary Yoshihide Suga, "the second most powerful minister after Prime Minister Abe," who said that the government would be watching FX with a "sense of urgency."

"This comment came out following the joint monetary policy meeting between the MoF, the BoJ and the FSA early this afternoon," he said.

"It's no doubt that the government is becoming more nervous about the recent volatile moves in the Japanese currency which are dampening the stock market severely, the most important economic indicator for the Abe administration," Takashima said.

Nevertheless, given that the May G7 Summit in Japan, and Prime Minister Shinzo Abe's recent meeting with President Barack Obama, it is "quite unlikely that Japan resorts to FX intervention" to stem yen strength, he said.

Citi maintained also that additional monetary easing by the BOJ "will not be welcome under this political environment."

All that the Japanese government can do currently is to proceed with organizing the fiscal stimulus package, "which is said to be announced by PM Abe this May before the Summit," Takashima said.

Citi remained bearish towards the yen, i.e. was dollar-yen bullish, in the medium-term and looked for "the fiscal stimulus measures that the government is organizing" to "give support to Japanese equities, and weaken the yen.

"Although the FX market doesn't usually react to fiscal policy like it does to the monetary side, it's evident that the demand creation power of the former is greater than the latter," Takashima observed.

Given today's break below Y110 in dollar-yen and tumble in the Nikkei 225 to lows last seen Feb. 17, there was increased speculation about what the BOJ might do when it meets April 27-28.

Kazuhiko Ogata, chief Economist Japan at Credit Agricole CIB, pointed to Monday's release of the BOJ Tankan's special survey on inflation, showing further fading in firm's mid to long term inflation expectations, and said the survey suggested that further BOJ easing action is "just a matter of time."

CACIB's main scenario remains unchanged, i.e. that the BOJ will announce additional monetary easing at the June 15-16, just after the G7 summit May 26-27 and ahead of the July Upper House elections.

"That said, we also see the odds on our sub-scenario have materially risen that the BOJ's next action may be frontloaded to the timing of the 27-28 April meeting, as the Nikkei 225 stock price index plunged below the critical threshold of 16,000 today," Ogata said.

"We may change our main scenario before long," he added.

The Nikkei 225, closed down 2.4% at 15,753.82 Tuesday, after trading in a 15,698.55 to 16,066.18 range.

On March 14, a day when dollar-yen was again flirting with Y114 highs, the index topped out at 17,291.35, the highest level since Feb. 3.

Back on Feb. 12, a day after dollar-yen first fell to lows near Y111.00, the Nikkei 225 hit a low of 14,865.77, the lowest levels since October 2014.

The BOJ left policy unchanged at the March 15th meeting, preferring to allow the market to further digest its adoption, in late January, of "Quantitative and Qualitative Monetary Easing with a Negative Interest rate."

QQENIRP failed to have the desired effect of underpinning Japanese stocks and weakening the yen.

"The BOJ officials have explained the timing of the NIRP as being a precautionary step taken ahead of corporate capex decisions," said Stephen Jen, managing partner at SLJ Macro.

"The reality, however, is that the January 29 decision was almost entirely related to the stock market volatility in January," he explained.

Additional easing at the April meeting "does not seem that probable, given the dramatic action already taken" back in January, "and the sense that the BOJ has already passed the point of diminishing returns on its stimulus policies," Jen said.

While the BOJ could act April 28, "the impact of such a policy is likely to be very muted, if positive at all," he said.

Fiscal stimulus, on the other hand, "is much more likely," Jen said.

The BOJ board will digest the March Tankan, reports from the bank's branch managers and other indicators ahead of its policy meeting in April, when the central bank will update its medium-term growth and inflation forecasts for the new three-year projection period through fiscal 2018 ending in March 2019.

In recent sessions, there have been various media reports suggesting that Prime Minister Shinzo Abe may announce a new fiscal stimulus plan before various G7 events in May and that the plan might include a delay in the planned April 2017 consumption tax hike.

There have been rumors of such a delay for many months and Japanese officials have tended to downplay such prospects.

Looking ahead, G7 finance ministers and central bank governors will meet May 20-21 in Sendai City, with their discussions setting the tone for the G7 Summit May 26-27 in Ise-Shima.