Fundamental Forecast for Japanese Yen: Bullish

- How long will risk appetite run astray of fundamentals?
- Unemployment hits a record low through July, deferring the timing of an economic recovery
- Will the rest of the yen crosses follow GBPJPY’s plunge this past week?

While other majors’ economic calendars have been filled to the brim, there are comparatively few Japanese economic indicators due for release next week. However, that doesn’t mean the yen will be relegated to tight ranges. The light docket belies the heavy event risk that is looming for the single currency. This weekend, the nation will go to the polls to vote in the first general election since 2005. Such a political episode is always market moving; but the fundamental implications in this election run especially deep as the world’s second largest economy is struggles to recovery from its worst recession in history and opinion polls suggest a change in power (and therefore policy approach) may be in the cards. And, if this wasn’t enough for market participants to worry about, there is always the high correlation to market sentiment to worry about. Tight ranges and stalled rallies should concern rather than pacify the astute trader.

First and foremost on the table is the general election that is to take place on Sunday the 30th. All 480 seats of the House of Representatives are open to the ballot – and for those unfamiliar with the Japanese political system, the house designates the Prime Minister. Clearly, there is at lot at stake from the traders stand point in this event risk. Whomever has control over the government will set vital policies that will steer the economy’s recovery from its worst recession since WWII. The uncertainty surrounding the event alone is enough to shake what confidence is still inherent in the yen. Even before the recent financial and economic crisis, Japan was mired in what is popularly coined a ‘lost decade’ of feeble growth, deflation, high savings and weak domestic investment trends. This is a wily ship to helm. What makes it even more interesting is that early opinion polls suggest the ruling coalition of the Liberal Democratic Party (LDP) will be unseated for the first time in nearly half a century by the opposition Democratic Party of Japan (DPJ). Admittedly, both their economic policy outlines are similar and spotty; but the desire to make an immediate impression and take control of the recession would likely see more immediate reaction should the DPJ win.

Beyond the immediate volatility following the market open after the election is decided, the outcome of this political shuffle will have a lasting impact on the Japanese economy and currency. Yet much of its influence will be subtle. In contrast, general risk appetite trends could cause severe waves for the yen over the coming week. Over the past few weeks, bullish sentiment has stalled. The S&P 500 has stalled below 9,635; crude has failed to surmount $75/barrel; and carry trade has tested the same 10-month high through all of August. Either these markets will have to push through or retrace; and with the progress of these speculative markets, we will see sentiment unfold. Supporting an ongoing bull wave, there is still immense amounts of side-lined capital that can find its way into the market. However, even if there is another leg of the now five month advance, it will likely be short-lived. Sentiment is waging a heavy premium over what fundamentals suggest the recovery can support and the lack of investment turn over can produce in returns.

Finally, we should not ignore the data on Japan’s economic docket. There are few readings on hand; but they are potent in furthering growth forecasts. Housing starts and vehicle sales will offer a look into the availability of consumer credit and the willingness to purchase big ticket items given current market conditions. Further up the economic stream, industrial production will measure orders (domestic and foreign) by translating what it will mean for local growth and employment. The 2Q capital spending will benchmark this same sector.

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