Fundamental Outlook for Japanese Yen: Bullish

- A pull back in volatility may be the eye of the storm for investor sentiment
- Japanese employment, consumer sending, factory activity pushing economy deeper into recession
- Global interest rates quickly approaching zero, suggesting the eventual rebound will be a slow build for FX

Risk sentiment dominated the markets last week; and it will no doubt do so again next week. This is a promising trend for Japanese yen traders who are looking for volatility – and nail-biting for those that await a lasting trend. Among the major economic drivers for next week, half are scheduled and the other half are potential. From the impromptu column, there is still considerable uncertainty held over the health of the world’s economic health and its financial markets. Policy officials have grown somewhat over-zealous in their attempts to force stability on the masses; and so far, they have failed to inspire confidence. Is this a sign that a certain dollar, euro or yen figure - one that investors are confident offers a full safety net on the global economy - has not been met? Realistically, there is no such number; and if there were, it would bankrupt the world governments. Fear has lasted because there is still significant exposure through leverage and credit; and investors (as well as consumers and businesses) will take any opportunity to unload that risk whenever they are given the chance. And, as interest rates tumble, government debt ratings come under pressure and global growth cools, the equilibrium between risk aversion and risk appetite will elude the market – putting a bottom to pessimism further out of reach.

These unspecified and unscheduled will remain the greatest threat to sentiment (and thereby the yen); but we will also find milestones for benchmarking these intangible factors along the way. Over the coming week, a few trends will be particularly important for deriving direction from the yen crosses. The most readily accessible driver will be interest rates. Three major central banks are set to announce their rate decisions over the period and each has its own place in the bigger scheme for risk. The Reserve Bank of Australia (RBA) is one of the few remaining, high-yield currencies out there; but a steady diet of hearty cuts has quickly lowered this benchmark and drug down the overall expectations for returns when things do turn around down. Another 100 basis point rate cut will lower the return side of the market’s scales of risk/reward. The Bank of England’s (BoE) forecasted 50 basis point cut to merely brings another key policy authority within reach of zero; which means officials will have to search out alternative policy methods. Finally, the ECB marks the dark horse, as uncertainty over its pace is shares a large responsibility in keeping expectations for an eventual return to risk appetite alive.

In contrast to returns, earnings and growth updates will gauge the level of fear in the market. While massive amounts of funds are being pumped into financial institutions and government guarantees are being stamped on corporate debt, we have seen the global recession put severe strain on earnings on the other vital sectors of the world’s economies. As the damage is tallied, investors realize just how bad the outlook really is. As for growth, there are many indicators that will offer minor adjustments to such a prominent forecast; but it will be the US non-farm payrolls report that offers the accessibility and influence that event risk and long-term fundamental traders crave. Another contraction on par with previous readings will signal to all that there is little doubt that the first quarter of 2009 is going to be worst than the final quarter of 2008.

John Kicklighter a Currency Strategist at FXCM.