Fundamental Outlook for Japanese Yen: Neutral

- Early warnings temper surprise in the Fed’s Stress Test Results, further encouraging investment
- Risk and yield appetite courses through the market; but fundamentals make for a dangerous ascent
- Technicals see an end to USDJPY congestion on the horizon

It is two different things completely to analyze the health of the Japanese yen and forecast the direction of USDJPY. For the pair, an intense focus on market sentiment produces excessive levels of volatility and a general lack of direction. This difficult to trade chop arises because both currencies are considered key safe havens and are therefore on the same side of a very influential fundamental driver. On the other hand, when the yen is considered alone, there is a clear sight on direction and momentum. The market’s renewed demand for yield and Japan’s economic woes leave the currency at the mercy of investors’ fickle sentiment – which could surge or reverse with little warning.

As always, the yen crosses are likely to take up the same direction as general market sentiment. Through the close of this past week, we have seen a gradual, bullish bias turn into a blatant scramble for yield. For the Japanese currency, these conditions couldn’t be any more discouraging. While the yen may have lost its status as the market’s top safe haven to the dollar; it is still considered a market for funding and not investment. What’s more, as fear is further deflated by governmental efforts to snuff out the financial crisis and the credit market stabilizes, there is an additional interest in rooting out economies that are strong enough to generate returns in a competitive world. If there were any factor more depressing for the yen than risk appetite (and the carry implications it holds) , it would be growth. The world’s second largest economy contracted at a staggering 12.7 percent pace through the first quarter – the sharpest decline in a quarter of century. What’s worse, forecast for the revision due the following week call for a far worse pace; and policy officials have tried to temper panic by warning that the second quarter performance may be worse. Therefore, the yen is double exposed to a sustained recovery in risk appetite. On the other hand, if capital once again is on the hunt for refuge, Japan will not be the optimal safe haven due to its economic woes.

Taking stock of risk appetite and its influence on price action is vague and imprecise. There are no clear indicators or events that could categorically alter the market’s taste for yield (like the Fed’s Stress Test and the few rate decisions were able to do last week). In the meantime, there will be specific data to take redirect forecasts for long-term growth; and perhaps even stir volatility for the yen. For timely indicators, the Leading Index and Eco Watchers will provide an objective and subjective measure for economic activity heading into the second quarter. Notably, both are expected to show some improvement. The trade figure is another significant release. Considering the rebound timid rebound in activity for so many developing countries over the past few months, fundamental traders will be looking to see whether a domestic recovery translates into demand for Japanese exports.

John Kicklighter a Currency Strategist at FXCM.