Fundamental Outlook: Bearish

- G7 forecasts a ‘weak’ rebound later this year; though banks’ toxic assets still a serious problem
- Japanese trade balance marks it worst annualized deficit in 29 years
- Bank of Japan Governor Masaaki Shirakawa tells economists not to mistake a temporary rebound as a genuine recovery

There is an ongoing debate as to whether the yen is a sensible safe haven currency considering the financial and economic troubles Japan is suffering. This is argument that will carry over into next week – and just as the market’s tolerance for risk is put to the test through a wave of major fundamental catalysts. Therefore, traders will first have to assess the ever-fluctuating level of sentiment through G20 and IMF policy statements, a mooring US first quarter growth report and ongoing register of market health derived through earnings releases. Then, they will have discern the level of optimism or panic that is borne from this mix and judge whether the Japanese currency is a viable safe haven via the depth of its markets and sheer size of its economy. Anything less than borderline fear or a dour forecast for the markets will likely see the once sacrosanct safe haven / yen correlation drift apart.

First, in taking stock of the economic mines that could leverage panic and volatility; we can see that there is a lot to keep track of. This weekend, the spot light will fall on the various meetings scheduled for the world’s policy makers. The G7 meeting has already passed with little more than cheerleader optimism; and any G20 statement is likely to provide little more. What traders really crave is tangible policy steps with responsibility and consequence along the way that can truly put the world on track to correcting what is clearly a global problem. To the extent of its capabilities, the IMF’s semi-annual meeting will likely produce better results. However, while this group has been very blunt on the current state of affairs and what needs to be done to genuinely turn economic activity around; the organization doesn’t have the clout to push policy onto the world’s leading nations. Moving beyond the weekend, the risk barometer will find input from the change in sentiment derived from earnings. Better-than-expected revenues is not the same thing as profits that are expected to expand as the year progresses. Net profit, write downs, delinquencies and non-performing assets are components that will not be overlooked. Finally, in measuring the health of the financial markets; we first gauge the health of the economy that supports it. The first quarter reading for US GDP will fill this role nicely. Should the world’s largest nation report a slower pace of contraction as expected, it could interpreted as the first (meaningful) step towards a working recovery.

After assessing the ebb and flow of risk sentiment, the fundamental crowd then has to decide whether the yen is indeed the proper currency to represent safety. This leads us to examine the health of the island economy. Over the past few days, Japanese policy officials have painted a grim outlook for economic activity (even taken within the context of a global recession). Despite confirming the worst recession for the world’s second largest economy in over a quarter of a century through the fourth quarter, the Bank of Japan’s top economist predict worse over the opening months of this year. The same sentiment was shared by BoJ Shirakawa. Data is working hard to confirm such fears as well. This past week, the ministry reported the worst annual trade deficit in nearly three decades. This will be followed up by employment, spending, factory activity, and auto sales data in the days ahead. When measuring this economic fodder against sentiment, questions will only arise should pessimism reign. Otherwise, if sentiment is improving, there is no need for a safe haven and the bleak future for Japan means there is really no reason to buy yen.

David Rodriguez is a Currency Analyst at FXCM.