By Chris Tedder, Research Analyst,

A combination of yen weakness and US dollar strength has pushed USDJPY even higher. As we outlined this morning, the weekend’s events in Jackson Hole sent investors flocking to the USD and away from the yen. The ensuing yen weakness has helped to spark a rally in the Nikkei, with investors hoping that the lower exchange rate will breathe new life into Japan’s struggling export market.

The sell-off in the yen was sparked by some stock standard dovish comments from BoJ Governor Kuroda over the weekend. Kuroda vowed to continue the bank’s program of aggressive monetary easing as long it’s needed to spur the economy. Yet, the governor also remained stubbornly optimistic that the economy isn’t as bad as some market participants fear.  He stated on Friday that “although exports continue to be relatively weak, domestic demand, including consumption and investment, will continue to expand in coming quarters”.

Kuroda’s stubborn optimism is starting to wear thin

The BoJ is more optimistic about the outlook for the economy than most market participants. On Sunday, Kuroda said that Japan may hit its 2% inflation target as early as this fiscal year, but this is highly unlikely. While the economy may have brushed off the worst effects of April’s hike in the sales tax, it remains in a very fragile position. Even if domestic demand begins to show signs of life, which is a big if, the export market isn’t performing as well as it should with the yen at such low levels.

Exports were supposed to flourish on the back of a weaker yen, yet a lack of international demand for Japanese goods is posing a real problem for growth. Exports dropped 2.0% in the year to June, after dropping 2.7% y/y in the prior period. The numbers were so bad that even the stubbornly optimistic BoJ was forced to highlight the recent weakness in the export market.

A weaker yen shouldn’t guarantee a strong rally in the Nikkei

This brings us to today’s rally in the Nikkei. The inability of the export sector to materially respond in a positive way to a weaker yen casts doubt over any substantial rally in the Nikkei due to a weaker domestic currency, thus we expect today’s rally may run out of steam. In fact, we remain bearish on the Nikkei as a whole, with weak data and few prospects for growth and inflation guaranteeing that investors remain cautious.

USDJPY’s path of least resistance looks to higher

USDJPY continues to smash resistance zone after resistance zone as it marches higher. Ultimately, the pair may run into a wall of resistance around 105.50, but we cannot rule out some short-term weakness. In any event, with both central banks on data watch, a slew of potential headline making economic data out of the US and Japan this week may determine the near-term future of the pair.