Fundamental Forecast for Japanese Yen: Bullish

- Japanese Yen Plunges Against Australian dollar on Return To Risk
- US Recapitalization Plan Fails to Sink Risk-Friendly Japanese Yen
- Japanese Demand Falters, Stokes Recessionary Fears

The Japanese Yen was one of the few currencies to lose against the US dollar through the past week of forex trade, as a marginal improvement in global risk sentiment and the US Dow Jones forced pullbacks in the Japanese currency. Yet the recent lull in financial market stress hardly suggests that the worst is over for global equity markets. We maintain our fundamentally bullish bias for the Japanese Yen, as cursory look at key credit and equity market indicators shows that conditions are far from normal. The spread between 3-month US Dollar London Interbank Offered Rates (LIBOR) and 3-month US Treasury Bills remains at an astounding 362 basis points. Prior to the onset of the subprime crisis in 2007, this same Treasury-Eurodollar spread averaged below 40 basis points. It remains all-too-clear that recent central bank actions have not yet forced significant improvements in interbank lending markets, and this will continue to raise borrowing costs and crimp corporate earnings through the foreseeable future.

A closer look at equity markets likewise suggests that there remains significant stress below the surface—boosting prospects for safe-haven Japanese Yen. The US S&P 500 finished the week over 8 percent above recent multi-year lows, but its Volatility Index (VIX) continues to trade near astounding record highs. The VIX, often referred to as the “fear index”, measures 1-month volatility expectations on an annualized basis. Thus its current value of 70.33 percent implies that options traders predict the S&P 500 will fluctuate by over 20 percent through the next 30 days—a truly noteworthy sign that traders fear extensive equity market volatility. We believe that such clear signs of financial market stress will make it difficult for major currencies to rally against the highly risk-sensitive Japanese Yen. The US Dollar/Japanese Yen currency pair remains strongly correlated to the Dow Jones Industrials Average.

Domestic developments have had little effect on the Japanese Yen through recent forex trade, and there is little reason to believe that upcoming economic data will force any noteworthy moves in major Yen pairs. Instead, we will keep a close eye out for any flare-ups in broader market volatility—especially as it relates to price movements across major global equity markets. It will be important to watch whether Asian markets can set the pace for equity trading through Sunday’s open. A strong rally through last week’s Asian equity market session set the tone for a weaker Japanese Yen through Friday’s close.

David Rodriguez is a Currency Analyst at FXCM.