Fundamental Outlook for Japanese Yen: Bearish

- Risk appetite stalls at multi-month highs as a dense wave of data passes
- Capital spending drops the most since records began in the first quarter
- How much momentum does Friday’s USDJPY posses? Read the weekly technical forecasts

It is no surprise that the Japanese yen has been on the short-side of so many trades over the past few months. Risk appetite has swept over the markets as optimists jump on the promise of ‘green shoots’ developing from the worst global recession in decades. However, what has been the yen’s part in this shift. It would be easy just to label the currency’s depreciation a sign of its carry currency role - though this would not be altogether correct. Through the financial crisis, capital flows naturally reversed course as large market participants unwound their extensive carry positions. Given enough time, however, this trend would naturally exhaust itself; and then the yen’s appreciation would depend on its role as a safe haven – a role never fit well. Prospects of a particularly severe recession and another decade of struggling with deflation certainly do not paint the picture of an ideal refuge from a financial storm. Now, with optimism picking up and investors able to exercise discretion in their investments; they can take a more critical analysis of the currency and its economy. The ultimate consensus on the standing of the yen from both a fundamental and sentiment perspective can be seen in the sharp sell off against the dollar (another safe haven currency) after a round of ‘better-than-expected’ US employment figures.

So, from the yen’s weakness against high-yielding and other similarly-predisposed safe haven currencies; we can deduce that the Japanese currency is met with headwinds should risk appetite rise or fall. However, as sentiment pushes to extremes, the yen will once again fall into safe haven role. This leaves us to speculate on how risk appetite will fair next week and what will be the intensity of the bias. That is the 64 thousand dollar question for a market that is so highly correlated. The standard barometers for sentiment (equity indexes, yield-heavy currency pairs, etc) have all stalled this past week. This pause was likely in observation of the heavy round of economic releases from interest rate decisions to GDP revisions to employment data. Looking ahead, there are many of these market-wide indicators. A potential dampener may be the G8 meeting in Italy scheduled for Friday and Saturday. The collective forecasts and plans of action could discourage wild shifts before the details of the gathering are released; and the event could spur the market itself given the right commentary.

In searching out the catalysts for and pace of market sentiment, we should not disregard the impact of native economic data on the battered Japanese yen. Just a short time ago, both the Cabinet Office and Bank of Japan released forecasts that called for the pace of the nation’s recession to ease going forward. This aligns itself to what other policy authorities have said and a few bright spots on the economic calendar; yet it is still a bold prediction. Skepticism will remain until objective data can confirm what the economy’s cheerleaders have professed. The most thorough measure of health next week will be the final reading of 1Q GDP, which will no doubt confirm the worst slump on record. The more timely indicators could bolster sentiment though. The trade balance, Eco Watchers survey, consumer confidence survey and leading indicators index are all expected to show measured improvements next week. This round of data will be good for minor adjustments on long-term trends; but don’t expect them to generate much in the way of volatility on their own.

John Kicklighter a Currency Strategist at FXCM.