Fundamental Forecast for Japanese Yen: Neutral

- FinMin Fujii Threatens Act on Currency in Case of “Excessive Moves”
- Current Account Narrows as Exports Fall Most Since January
- Speculative Sentiment Points to Bullish Outlook for Japanese Yen

Japanese Yen volatility may surge in the coming week as the currency’s recent gains test policymakers’ disposition about direct intervention into currency markets. The economic calendar is generally uneventful in the days ahead, with the interest rate announcement from the Bank of Japan the only somewhat notable item on the docket. With rates firmly in place at 0.10% for the foreseeable future and no indication that the bank is in a hurry to alter its unconventional easing programs, the meeting would be another non-event (as has been the case in recent months) if not for the Yen’s rapid appreciation over the past two weeks. Indeed, the Japanese unit seems finally ready to take up directional momentum after a trade-weighted index tracking its value against other top currencies broke higher out of a range that had contained it since early March. A rising currency does not bode well for Japan as the world’s second-largest economy begins to show fragile signs of recovery from the worst of the global economic downturn, trimming export demand and crushing any would-be rebound before it ever gains meaningful traction. This leads us to the inevitable question: will Japan intervene to drive down the Yen?

Japanese authorities’ last foray into currency market intervention was a campaign spending a whopping 35 trillion yen over 15 months ending in March 2004. For his part, newly minted Finance Minister Hirohisa Fujii has been back and forth with his stance on intervention over recent weeks, initially arguing that it was not the government’s job to mettle in exchange rates only to backtrack and say that the Ministry of Finance could act on the Yen if its moves were seen as “abnormal”. In the meantime, a handful of smaller Asian nations including South Korea, Hong Kong, Taiwan, Thailand, the Philippines and (possibly) Indonesia moved to buy US Dollars against their local currencies last Thursday. This gives Japan a greater incentive to enter the markets, fearing that orchestrated depreciations of other Asian currencies will give their countries a disproportionate advantage in courting overseas buyers. Japanese Prime Minister Yukio Hatoyama is set to make high-profile visits to China and South Korea over the weekend, pushing for the creation of an East Asian Community along the lines of the EU. Deeper economic cooperation is seen as the first step to such an outcome, and Hatoyama coordinating currency policy could be very high on the list considering Seoul’s recent actions.

So far, Japanese authorities have shied away from stepping into FX markets despite a drop below the 90.00 figure in USDJPY, a level that had been seen by many market participants as the threshold of policymakers’ comfort zone. This suggests that perhaps the new DPJ administration has not yet made up its mind on currency policy and will perhaps attempt to talk down the Yen before resorting to a more direct approach. Two obvious opportunities to issue such comments present themselves during Hatoyama’s talks with the Koreans and the Chinese and the Bank of Japan policy meeting. Indeed, BOJ Governor Maasaki Shirakawa would likely be seen as a more credible voice if speaking against Yen strength, which stands to produce a greater reaction from the market. Beyond these, traders will likely pay close attention to comments from any key players in the Japanese establishment, hinting at choppy volatile price action in the days ahead.

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