Fundamental Outlook for Japanese Yen: Bullish

- Japanese yen surges to a 13-year high after US auto bailout falls through
- Eco Watchers report marks the worst level of merchant sentiment on record
- Speculators fading yen’s record breaking advance to the end

The Japanese yen saw a massive surge across the board through Friday’s Asian session; but this momentous move would ultimately be unwound before volatility receded for the weekend. Now traders are left to wonder whether this was the sign of a bigger fundamental shift behind the carry strategy’s perennial funding currency or a errant technical move that has altered the fundamental future of the key FX safe haven.

Looking back to the trigger of the 370-point dive in USDJPY, it is clear that the failed US auto industry bailout was the culprit. However, the quick reversal (in all the yen pairs) suggests that this was a false alarm for the next freeze in the lending activity and plunge for capital markets. Fundamentally, the sharp turnabout could be explained by the White Houses assurances that they would hold the American industry until lawmakers could reconvene to decide a more permanent solution. On the other hand, there is likely a sentiment component to this reversal as well. With the yen threatening major breakouts against all of its major counterparts (against the dollar it had already cleared resistance and was trading at a 13-year high), the market was reminded that liquidity was fading fast going into the year end / holiday session. A break of this magnitude would have dramatically altered the currency’s path and perhaps even general risk sentiment in the currency market – like an accelerant. This will be a key influence in the week ahead. Should the yen’s bull trend be revived, it could dramatically alter the sentiment and pace of the market. Many hidden risks represent potential economic mines that could catalyze such a move. The auto bailout is still a big question mark for the spread of the financial crisis. At the same time, other national rescue efforts are on the verge of failure. This is not surprising as central banks have lowered rates to near zero while policy makers are running out of money, all while the recession steadily deepens.

Outside the uncertainty of risk trends in a thinning market, yen traders will also turn their attention to activity in the Bank of Japan. Should the market try to pull USDJPY below 90 once again, traders will do so looking for signs of intervention from the central bank. Policy officials have an active history of intervening and have said recently that they would act to bolster the exchange rate – a critical component for growth in an economy that is heavily dependent on exports. In the past, the BoJ has proven itself an adept trading group that acts at the exact right time to trigger at least medium-term reversals. However, they usually do not announce their presence in the market until well after the fact (they may have played a hand in the reversal on Friday). In addition to this latent risk, the central bank will also play its part through a rate decision. Economists and market gauges expect the benchmark cash rate to be held at 0.30 percent (allowing the Fed to steal the title of lowest G10 yielder should they cut as deeply as traders expect); but there is potential for easing to keep pace with its contemporaries under a highly pressured political environment. Regardless, there will also be the statement to offer speculators fundamental fuel. With the bank just a step away from falling back into the trap of a zero interest rate policy (ZIRP) without signs of any genuine improvement from growth going forward, traders and consumers will be looking for policy alternatives to revive the market.

John Kicklighter a Currency Strategist at FXCM.