Fundamental Forecast for Japanese Yen: Neutral

- Japan’s Current Account Surplus Swells as Exports Surge in June
- BOJ Leaves Rates Unchanged, Says Economic Conditions Have “Stopped Worsening”
- Corporate Goods Prices Unexpectedly Gain on Rising Import Costs

The Japanese Yen outlook looks murky in the week ahead as risk trends compete with a nominally recession-ending second quarter Gross Domestic Product report. Short term (30-day rolling) correlation studies reveal the Yen’s average value against a trade-weighted basket of top currencies is now -90.4% inversely correlated with the MSCI World Stock Index. This means that the Yen is likely to strengthen if stocks should reverse lower, an outcome that we have argued is quite likely for some weeks now. Indeed, global markets ended July trading at the highest level relative to earnings since October 2003 – a year when the global economy grew 2.7% in real terms – making them look decidedly overvalued at present considering the kind of earnings growth that can be expected in year when real World GDP is set to shrink for the first time in the postwar period. Technical positioning also looks to be hinting at a bearish turn ahead: the MSCI World metric is setting up a rising wedge bearish reversal chart formation and showing negative divergence across momentum studies.

The second-quarter Gross Domestic Product report tops the list of scheduled event risk, with expectations suggesting the world’s second economy grew 1% in the three months through June, marking the first positive outcome in a year. In annualized terms, the result is even more impressive, with forecasts pointing to a 3.9% expansion versus a record -14.2% drop in the first quarter. Government stimulus both at home and abroad likely accounted for the improvement: Prime Minister Taro Aso spent a whopping 25 trillion yen to replace sagging private-sector demand while aggressive public spending and a government-induced lending boom in China, Japan’s top trading partner, helped drive overseas sales. From a long-run perspective, the sustainability of such measures seems shaky at best as the government racks up hefty deficit and China reins on fears of a forming credit bubble. That said, the market may still get enough fuel for short-term volatility out of the release. The likely directional bias of the Yen’s response is difficult to indentify, however: intuitively, the positive GDP result seems likely to boost the currency, but the Japanese unit’s inverse correlation with risky assets may mean that the release drives stock valuations higher but send the Yen lower.

If nothing else, this week will help traders separate and rank the potency of the various factors driving Japanese Yen price action going forward, aiding in building an informed directional bias for the months ahead.

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