nikkei 225 volatile and dangerous waters ahead of the fed 1313372015

It has been a wild week for the Nikkei as investors juggle with the prospect of looser monetary policy in Japan, tighter interest rates in the US and more soft Chinese economic data. On Monday, the Nikkei 225 was assaulted by bears after the release of soft economic data from China and Japan (the former released a deluge of disappointing economic data and the latter released soft industrial production numbers), with the index falling around 1.6%. This was followed by a strong rally on Tuesday morning on the back of hopes of further easing from the BoJ, but the bank left policy unchanged, causing the Nikkei to fall in the afternoon.

Industrial production rose a disappointing 6.1% y/y in August, missing an expected 6.5% rise. Also, retail sales missed estimates and fixed asset investment growth slowed to its weakest pace in 15 years. This deluge of data misses came in the midst of a critical time for the Chinese economy, as Beijing attempts to manage a persistent economic slowdown and turmoil in its stock markets. The clouds over China’s economic outlook, Japan’s largest trading partner, are drifting over Japan and weighing overall investor sentiment.

Nonetheless, the biggest event for the Nikkei this week, and for the rest of the market for that matter, may be the Fed’s monetary policy meeting on Thursday. This may be the most anticipated central bank meeting of the year. The market is juggling the idea of tighter interest rates in world’s largest economy and the impact this will have on asset prices and the global economy. The US economy is looking more and more primed for tighter monetary policy on the back of a strong labour market and a heightened level of economic activity. The only ingredient missing is inflation, which is a huge part of the policy mix. In fact, the lack of inflation in the US may be enough to keep the FOMC from raising interest rates this time around; the market is only pricing in around a 28% chance of a move this time around. Whatever the Fed’s decision, there’s likely to be a significant amount of volatility surrounding this meeting.

Market reaction – Nikkei

If the Fed goes against the grain of the market and raises interest rates it could sour investor sentiment in the US and damage global risk appetite. However, it could also lead to a strong rally in the US dollar, weakening the yen which is generally a positive for the Nikkei. Overall, the stage is set for a very volatile time for the Nikkei, especially if we continued to see increased volatility in USDJPY.

From a technical perspective, the Nikkei 225 is still looking a little vulnerable around 18,000 and amidst this increased volatility (see the chart below with the volatility envelopes). Since the sell-off began in early August, the Nikkei has lost around 12%, which includes a retracement last week. There’s still some support around 18,000, before the index’s recent low around 17,427.

Nikkei 225

Source: City Index