Fundamental Outlook for Japanese Yen: Bearish

- US Dollar breaks major resistance against the Japanese Yen
- Japanese Yen trading becomes difficult on break with risky assets
- Forex Sentiment suggests USD/JPY may be topping

The Japanese yen fell substantially against the US Dollar, as the weight of dismal economic data finally proved to be too much for the safe-haven currency. Indeed, the correlation between the USD/JPY and the S&P 500 unexpectedly turned negative; financial risk sentiment deterioration actually led to sharp US dollar gains against the yen. Whether or not this shift will be sustained will have a substantial impact on Yen price action. We maintain that the JPY will continue to gain on financial market sentiment deterioration, but a shift in market correlations clearly adds doubt to our forecasts.

Traders arguably expressed their displeasure with absolutely dismal Japanese GDP reports in dumping the yen against the dollar, but it remains to be seen whether upcoming economic data will have similar impact on the USD/JPY. The domestic economic calendar is ostensibly busy through the week ahead, and we will have to keep a close eye on market reaction to key data points. The first bit of noteworthy event risk comes on Monday night’s Bank of Japan Policy Meeting Minutes. Any substantive shifts in monetary policy could bring similar moves in the yen, but the BoJ has made its intentions fairly clear up to this point and we do not envision major announcements. It will arguably be much more important to watch later Trade Balance numbers and a slew of other late-week economic reports.

A sizeable trade balance surplus represents one of the Japanese yen’s most important sources of support. For years, analysts and traders argued that the JPY stood to gain substantially due to its impressive Balance of Payments advantage over the US dollar and other key currencies. In retrospect, risk appetite and carry trade demand have been far more important drivers of broader forex price action and in the yen itself. Yet traders are finally starting to take note of the fact that Japan’s highly export-dependent economy stands to lose substantially from the ongoing global economic crisis. If the Japanese yen loses its link to financial risk appetite, it will trade on its fast-deteriorating economic fundamentals. Outlook for the Yen remains extremely unclear, and the coming week could potentially bring major shifts to our own USD/JPY forecasts.

David Rodriguez is a Currency Analyst at FXCM.