Disappointment in G7 May Be Built In

This column was originally published on RealMoney on Feb. 9 at 12 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Over the last couple of weeks I have consistently argued (in columns and the Columnist Conversation) that the European finance ministers were setting up the market for disappointment if the G7 statement does not single out Japan or express concern over the weakness of the yen. I had thought such disappointment would hit the yen hard. However, the price action now has me suspecting that the market has sold yen on speculation about disappointment and is vulnerable to a buy on the fact.

Although this may strike some as counterintuitive, there's a market logic to the argument. Of course, with the Japanese markets on holiday Monday, there might be an initial spike down in the yen in early, thin trading. This might be better seen as an opportunity to book profits than the start of a new leg down for the yen.

A few considerations also warn of the risk of near-term yen gains. First, Japanese institutional investors frequently sell foreign assets ahead of their fiscal year-end, March 31. Weekly data from the Ministry of Finance indicate that Japanese investors already have begun selling foreign assets. Meanwhile, the same MOF series indicates that foreign investors have stepped up their purchase of Japanese stocks and bonds.

Second, next week (Feb. 14), Japan reports its fourth-quarter GDP. Recall that third-quarter GDP was disappointing, dragged down by the weakest consumption figures since the retail sales tax was hiked in the late 1990s.

Japan is likely to report a strong rise in fourth-quarter GDP of around 1%, compared with a 0.2% increase in the third quarter. At an annualized pace, this is around 4%, which would mean that Japan was the best G7 performer in the fourth quarter.

Consumption is also likely to have rebounded smartly. At the same time, deflationary pressures in Japan probably eased. The deflator is expected to be -0.5% after a 0.7% decline in the third quarter.