Fundamental Outlook for Japanese Yen: Bullish

- The outlook for risk appetite is failing as the financial crisis spreads from Wall Street to Main Street
- A temporary surge in risk aversion breaks support on yen crosses. Will continuation follow?
- BoJ officials leave rates unchanged following last month’s cut. Running short on options

Volatility is extraordinarily high, not only in the currency market, but across all asset classes. However, for the past four weeks, price action has come without trend and in some cases it has consolidated into tight ranges. Something will have to give soon; and considering the fundamental environment, it will likely be congestion trends. Last week, the yen crosses were spurred into a false breakout when multiple reports reminded investors of the full scope to the ongoing financial crisis. Over the past few days, Iceland reportedly received $4.6 billion from the IMF and Nordic countries to prevent on sovereign debt (perhaps one of many countries that may come this close before the end); the SNB decided to cut its benchmark lending target 100 bps to 1 percent (reflecting an anxiousness that has been seen among many monetary authorities); the EU announced it would produce a region-wide bailout plan by next week (suggesting national efforts are falling short); a report suggests 32 percent of savings & loans are seeking bailout aid from the US (recounting the crisis of the late 80’s); and the big three US auto makers petitioned the government for $25 billion in aid. None of these issues is truly resolved and their prevalence across the global economy suggests the financial crisis has evolved into something much more insidious. Perhaps leveraged volatility generated over the upcoming week (owing to the US holiday) could be the catalyst that finally sets the market back into trends. If this is the case, the fundamentals are certainly calling for an unwinding of carry interest and consequently a rally in the Japanese yen.

Through risk aversion is likely the principle concern for yen traders over the coming weeks, economic indicators will certainly have their place in the long-term direction of the Japanese currency as well. When credit markets stabilize, traders will likely jump immediately to gauging the relative strength of economic activity across the G10 as a barometer for strength. In fact, we have already seen this dynamic having its influence on the market. The best example is the strength in the US dollar; which, though it is does have much of its fundamental bearing in its status as a safe-haven currency, is further encouraged through confidence that US policy officials have made the quickest and most extensive effort to solve the problem. Japan will take its place in this comparison – though the response will be a little different from this perpetual carry trade funding source. Friday morning brings most of the important data. Inflation, employment, consumer spending, factory activity and housing sector trends will all be measured in some form. Such a broad reading of economic activity will certainly redefine growth forecasts for the year end and into 2009.

Antonio Sousa is a Currency Analyst for FXCM.