Fundamental Forecast for Japanese Yen: Neutral

- Japanese Service Demand Unexpectedly Drops on Job Losses
- Bank of Japan Cuts Economic Growth Forecast, Extends Credit Easing
- Consumer Confidence Rose for the Sixth Consecutive Month in June

The Japanese Yen is likely to see volatility in the coming week as the flow of corporate earnings releases and the demise of CIT promise sharp swings in risk appetite while Japan’s new currency chief openly threatens forex market intervention if the Yen gets too strong.

Although the initial round of second-quarter results offered a strong start to the reporting season, the fundamentals behind the euphoria continue to look shaky. Indeed, shares are trading at the highest level relative to earnings since 2004, a year when the world economy grew 4.1% in real terms. The OECD, IMF, World Bank, and all major central banks are in agreement that the world economy will shrink this year, suggesting the markets have been more than a little overzealous in their optimism. Further, the earnings reports that have already passed have set the bar very high for upcoming announcements, making it all the more possible that a disappointing outcome will topple global exchanges.

The imminent collapse of CIT, a top-10 lender to small- and medium-sized businesses including a number of key retailers, could also weigh heavily on risk-taking. Beyond corporate loans, CIT is the third-largest provider of transportation finance (such as leasing rail cars for moving products) and the number one independent provider of vendor financing (such as the leasing of technology and office equipment). This means that the firm’s demise threatens to disrupt day-to-day operations of a large part of US businesses above and beyond the need for credit. CIT failed to convince the US government to back its debt, but only the onset of bankruptcy will show whether the market agrees with regulators that the firm is not “too big to fail”.

Stand-by yield-seeking trades like GBPJPY and all of the Japanese unit’s pairings with commodity-linked currencies are on average over 90% correlated with the MSCI World Stock Index, meaning that any return to risk aversion is likely prompt sharp carry-trade liquidation and boost the Yen. This could open the door for Japan to intervene into the currency market, judging by recent comments from the country’s newly-minted vice finance minister for international affairs Rintaro Tamaki: “We’ll make judgments based on whether excessive movements in the currency market will adversely affect the economy… if you were to ask me if we’d never intervene, the answer would be no.” Clearly, the current situation is tremendously unstable, creating a profoundly fertile environment for Yen volatility.

The economic calendar is noticeably tame given the aforementioned catalysts. Minutes from the last meeting of the Bank of Japan are unlikely to produce much more insight beyond the initial policy announcement while the expected expansion in June’s Merchandise Trade Balance surplus seems predictable as an abysmal job market continues to weigh on imports.

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