Fundamental Forecast for Japanese Yen: Bullish

- Early-week financial market distress means Japanese Yen dominates
- Later, the Japanese Yen Dives as Carry Trade Recovers
- Forex trading market conditions improve as financial distress eases

The Japanese Yen saw an incredible week of volatility against the US dollar and other major forex counterparts, as dramatic shifts in the US Dow Jones Industrials Average and other major risky asset classes led to similar movements in the East Asian currency. Early-week news that Lehman Brothers filed for bankruptcy sent the Yen significantly higher through Sunday’s open, but subsequent announcements from the Federal Reserve and other major central banks seemed to bring temporary calm to financial markets. If Friday’s price action is any indication, it seems that traders are once again willing to take on risks and short the Yen against higher-yielding counterparts. Of course, we have seen market risk appetite vary dramatically in the past week alone, and our Japanese Yen forecast is far from clear on broader indecision across all traded markets.

The week ahead will likely see continued volatility in the Yen and other risk-sensitive currencies—especially as 1-week implied volatilities on JPY options remain at their highest since the Asian Financial Crisis and the collapse of Long Term Capital Management. Equity traders seem willing to take on risk and sent the DJIA to its best two-day performance in six years. Yet it is far from clear whether we can expect similar price action through upcoming forex trade, and JPY traders should be wary of the possibility that this is yet another “false dawn” for financial markets.

Our long-term Japanese Yen forecasts remain bullish, but the short term is far less clear. Key questions remain as to whether recently-announced US Federal Reserve and Treasury plans will be enough to bring a sustained calm to distressed credit markets. We see that safe-haven US Government bond yields have jumped substantially in a short two-day span, while equivalent money market rates have fallen. Such price action suggests that financial institutions are willing to leave the safety of Treasuries and seek higher short-term yields on the interbank lending market. If such trends continue, we could see the USDJPY rally further off of recent lows. Yet it serves to note that the US Dollar/Japanese Yen pair stopped abruptly at key technical resistance through Friday’s close—easing over 100 points before a smaller bounce. If the USDJPY is unable to test and break through the 61.8 percent Fibonacci retracement of 110.70-103.50 at 108.00, short-term risks remain clearly to the downside.

David Rodriguez is a Currency Analyst at FXCM.