Fundamental Outlook for Japanese Yen: Bullish

- Carry interest hits a new six-year low growth and financial troubles balloon
- The safe have yen and dollar may be losing their correlation to other risk-sensitive assets
- Global policy makers struggling to pull their economies out of steep recessions

There are two concerns for fundamental yen traders next week: risk trends and fundamentals. As the market’s preferred safe haven currency (retaining the title from dollar liquidity) though, sentiment and fear will no doubt hold the greatest level of influence the Japanese yen’s future. As usual, it is hard to forecast what events will arise, much less be particularly market moving. However, there are a few significant factors from this past week that will likely carry over to the near future.

Most notably, there will be a high sensitivity to the health of global financial firms. While it may seem that the US government’s $20 billion investment and $118 billion guarantee in Bank of America marked the end of just another potential bankruptcy, it instead highlights that round after round of liquidity injections, massive guarantees on debt, direct government investments and other efforts made until this point have not restored lender and investment confidence. With Citi announcing a split after a massive quarterly loss of its own and Barclays expected to suffer from the UK’s proposed ‘Bad Bank’ scheme, there is ample reason to believe another massive failure may be coming. Rating agencies certainly think this is a high probability outcome. In fact, Moody’s has forecasted defaults on speculative grade debt to hit 15 percent in 2009 as economic conditions turn ‘perilous.’

Aside from doomsday prophesizing, the economic calendar may also prove it is taking a greater influence over the yen’s future. As global interest rates trend fall closer to zero, the carry trade implications of this pair are reduced to nil. This leverages the currency’s support from being a net saver economy with large reserves as the most important factor to its retaining the title of a safe haven. However, should its growth deteriorate and financial markets crumble, Japan could surely lose its appeal as a destination for holding capital imbued with sense of fear. Through these concerns, we will see indicators like consumer confidence, the trade balance and service sector activity and the all sector indicator tout a greater influence over fundamental trends. More significant though will be the economic forecasts from the Cabinet Office and Bank of Japan. Though the policy officials are speculating like any trader (though access to data and experience probably make these more accurate educated guesses on the whole), their outlooks will act as a benchmark for everyone else to formulate their projections around. The BoJ’s rate decision (this time set with a hard time) this Thursday will work in a similar capacity, but without room for much in the way of traditional monetary policy, the real potential here rests in any suggestions that the central bank is turning to unorthodox efforts to save their economy.

John Kicklighter a Currency Strategist at FXCM.