The Japanese Yen finished almost exactly unchanged against the US dollar to end the week’s trade, but strong volatility from the US S&P 500 and other global risky asset classes made for an especially volatile string of trading days. In fact, forex options show that 1-week implied volatility on the USDJPY reached its highest levels since the height of market turmoil seen in March of this year and August, 2007. Such price action underlines the extreme indecision and general skittishness enveloping global financial markets—especially as rumor mills are rife with ‘news’ that major financial institutions will fail if not acquired by outside investors. A continuation of this game of rumors will likely make for another especially volatile week in the Japanese yen in the coming days of forex trading.

Fundamental Outlook for the Japanese Yen: Bullish

Some sources claim that a consortium of banks and private equity shops will acquire fast-falling Lehman Brothers shares over the weekend, and such an event would likely cause a sharp short-term rally in global stock markets—sending the Japanese Yen lower in its wake. Of course, we are far from certain on whether such an acquisition will occur. It is likewise clear that overall momentum remains to the downside for the US S&P 500, and a Lehman take-over may not quite add up to be the panacea that stock market bulls have hoped for. Just a week ago market commentators claimed that the US Treasury’s bailout of Fannie Mae and Freddie Mac would greatly improve financial market conditions, and it seems that such claims could not be further from the truth.

Whether stock markets and the forex carry trade can really improve in the week ahead seems almost entirely up to chance. Yet current market conditions are hardly supportive for short-JPY trades, as the Japanese Yen has historically strengthened during times of broader market duress. We would argue that risks remains to the topside for the Yen (downside for the USD/JPY) through medium and longer term trading, but we could plausibly see further Japanese Yen pullbacks through the coming week of currency trading.

David Rodriguez is a Currency Analyst at FXCM.