Geo-Politics Stifle Yen Run

The yen appeared ready for a turn in Asian and European trade today as USD/JPY finally dropped below 118.00 and EUR/JPY broke below 150.00 but early morning news from North Korea that it will conduct a nuclear test as part of a plan to bolster its self-defense amid what it called increasing U.S. hostility.

"The DPRK will in the future conduct a nuclear test under the condition where safety is firmly guaranteed," the North's Foreign Ministry said in a statement carried by its official Korean Central News Agency.

The news instantly stopped the yen rally in its tracks as speculators quickly abandoned their fresh yen longs for fear that the latest salvo from North Koreans may escalate geo-political tensions in Asia and force a test of the newly elected Japanese Prime Minister Shinzo Abe.

Given Mr. Abe's considerable diplomatic skills and strong preference for negotiation and consensus building the market may be overestimating the fallout from North Korea's latest move. Clearly the communist regime is in a reactive mode but may be ultimately persuaded by China to shelf its plans for a test.

In that regard Mr. Abe latest efforts to set up a summit meeting with his Chinese counterparts may prove critical to defusing the tension in the region. For now however, yen bullishness has been put on hold as currency traders step aside and allow the situation to resolve itself.

Meanwhile in Europe the euro continues to consolidate its gains after yesterdays weak US ISM number erased any possibility of an additional interest rate hike by the Fed by the end of this year. With the market anticipating an ECB rate hike to 3.25% this Thursday, some traders are positioning for a further EUR/USD run on hopes of hawkish guidance from Mr. Trichet.

The EZ economy however is beginning to show small signs of deceleration as interest rate hikes begin to take effect. Today's employment data ticked up to 7.9% from a yearly low of 7.8% set last month. Furthermore, the sharp decline in energy costs blunted some of the gains in PPI numbers which printed at 0.1% versus 0.2% expected mitigating the need for super aggressive monetary measures. All in all, the EZ data suggests that while the ECB may still have some room to tighten the amplitude of any additional rate hikes will be decidedly limited.