Japan market upheaval likely temporary but shows Abenomics' limits

Fri Jun 7, 2013 3:23am EDT

* Fall in Nikkei, dollar/yen viewed as necessary correction

* Abenomics magic blunted by Fed's QE tapering talk

* Analysts expect markets to stabilise soon

By Hideyuki Sano

TOKYO, June 7 (Reuters) - The yen's rebound to two-month highs and a rapid decline in Japanese shares are likely to be natural, if painful, corrections after one-way market bets, but they lay bare the risks and limits of Japanese Prime Minister Shinzo Abe's economic policy.

The Nikkei average fell into bear market territory on Friday from a 5-1/2-year high hit just over half a month ago, while the yen gained more than 7 percent from 4-1/2-year lows against the dollar to as high as 95.55 yen.

"The markets had been moving almost one-way so an adjustment was necessary," said Seiya Nakajima, chief economist at Itochu Corp.

"But if the Fed is really tapering its quantitative easing, then U.S. stocks will be capped and that's going to be tough for Japanese stocks," he added.

Indeed, the Nikkei's fall and the dollar's fall against the yen both started after Federal Reserve Chairman Ben Bernanke said on May 22 the U.S. central bank could decide to scale back its bond buying in the next few policy meetings.

The dollar's fall against the yen and some other currencies is counter-intuitive, as an end of U.S. stimulus would boost U.S. bond yields and normally lift the dollar.

But analysts said Bernanke's comments likely prompted some hedge funds, which had been counting on a prolonged period of cheap dollar funding, to cut their positions in many assets.

As buying in Japanese shares and selling in the yen were among the funds' favourite trades earlier this year, those markets were highly susceptible to corrections.

Many analysts think the dollar will stop falling against the yen soon, given that the Bank of Japan is just two months into its aggressive two-year stimulus plan, unlike the Fed, which could scale back easing in a few months if the U.S. economy shows more resiliency.

"The market had built up dollar long positions too much, so some of them are being unwound now," said Makoto Noji, senior strategist at SMBC Nikko Securities, noting that speculators' dollar long positions against six major currencies were at the highest level since 2000.

The dollar rose to a 4-1/2-year high of 103.74 yen last month, a gain of around 20 percent since the end of 2012.

An important support level is seen at 95.40, the so-called the cloud bottom on daily Ichimoku charts.

Still, a break there could open the way for a test of the April low of 92.57, which means the dollar will have lost all its gains made after the BOJ's massive bond buying programme in April.

"As long as that April low is not broken, we could say the dollar's uptrend is intact in the long term. Yet, it is difficult to expect a rally like before. We are more likely to see range-bound trade for now," said Ayako Sera, senior market economist at Sumitomo Mitsui Trust Bank.

In the same vein, analysts expect Japanese shares to stabilise soon after all the stop-loss selling is completed.

In fact, the Nikkei rebounded right near its Ichimoku cloud bottom on Friday, which was at 12,524 points. That level still represented a 20 percent gain from the beginning of this year.

The Nikkei came under additional pressure this week from disappointment after Abe's growth strategy unveiled on Wednesday fell short of concrete steps, such as labour market reform or putting more nuclear power plants online.

Bulls hope Abe is only delaying his decision until after the July election. A victory there is paramount to Abe, whose first term as prime minister in 2006 ended in tatters in about a year due to his health problems and fall in popularity.

But others say the latest market upheaval shows just how markets can become volatile when policymakers try to boost expectations by printing money without delivering reforms - a risk analysts said will persist.

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