Fundamental Forecast for Japanese Yen: Bullish

- Trade Surplus Swells as Unemployment Weighs on Imports
- BOJ May Resume Buying Corporate Debt, Meeting Minutes Show
- Jobless Rate Declines For Third Month as Workers Exit Labor Force
- Officials Step Up Currency Intervention Threats as Yen Pushes Higher

The Japanese Yen was the single best performer in the G-10 last week, adding 2.63% on average against other major currencies and soaring to levels unseen since 1995 against the US Dollar. As we suggested last week, the push higher came as capital continued to pour out of stocks, commodities and FX carry trades funded in the perennially low-yielding currency, with volatility amplified by thin liquidity around the Thanksgiving holiday in the US. Although volumes should be on the mend next week, the Yen is set to extend gains as risk aversion continues.

Last week’s stock sell-off was blamed on news that Dubai was seeking to suspend international debt payments, boosting fears of the largest sovereign credit default since Argentina in 2001. However, this seems to have been an excuse to speed up a larger underlying shift in global capital markets that likely began in October as a Morgan Stanley index of world stock prices fell the most in eight months while the VIX Index, a stand-by measure of investors’ fear, rose the most in a year. A correction lower in equity prices seems justified. Relative equity valuations have looked overdone for some time now with prices trading at the highest levels relative to earnings in seven years. Further, the market’s mood seems to be in transition, with the hearty sigh of relief that produced the risk rally of recent months giving way to more sober thinking about what is to happen once interest rates invariably reverse course higher and the flow of government cash dries up. There are no easy answers to such questions. Companies’ “better than expected” earnings of the past several quarters have relied heavily on cost cuts, which have usually come by way of firing workers. Naturally, one firm’s cost reduction is another’s lost demand as unemployed people reasonably cut back spending, so what has been good for stocks may prove far from encouraging for the economy as a whole as private demand is called upon to resume driving growth.

If stocks are to continue lower, the Yen looks well-positioned to build on recent gains as investors dump all manner of risky assets, including FX carry trades funded with borrowing on the cheap in the Japanese unit. The only meaningful threat to such an outcome is an increasingly shrill Japanese government that has apparently resolved to intervene against the Yen if things go too far. However, this would likely require a lot of cooperation between the Ministry of Finance and the Bank of Japan even as the leading economic policy bodies are tied up in a spat of over the central bank’s asset-purchase programs. This means any concrete action will be relatively slow to implement, giving traders an opportunity to push the Yen meaningfully higher still, especially after USDJPY slipped below a major technical and psychological boundary at 87.09.

The Japanese economic calendar is largely uneventful. Industrial Production is set to shrink at a slower pace in October as inventories continue to adjust and fiscal stimulus boosts demand around the world, but this offers nothing new with the underlying themes behind the improvement already thoroughly priced into the exchange rate. The pace of contraction in Housing Starts is also set to moderate, but the outcome is still expected to fall firmly along the downward trajectory that has been in place for over a year.

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