Fundamental Forecast for Japanese Yen: Neutral

- Yen COT Positioning Suggests Low May Be in Place
- Speculative Sentiment Also Points to Yen Strength
- Japan’s Trade Surplus Narrowed and Money Supply Fell Further

The Japanese yen was the strongest of the majors over the past week, rallying over 2 percent against the Australian dollar, Swiss franc, euro, and US dollar. The move certainly wasn’t fundamentally-based, as data showed that Japan’s trade surplus narrowed to 1.1 trillion yen in November, the annual rate of M3 money stock fell to 2.2 percent in December, while bank lending contracted in December for the first time in four years. This clearly doesn’t bode well for long-term interest rates in Japan as it signals not only economic weakness, but also deflation.

Looking ahead to the next week, there will be a number of economic releases from Japan. First, consumer confidence for the month of December could slump further, indicating a pessimistic shift following the ten straight months of improvement we saw between December 2008 and October 2009. Next, the Cabinet Office’s monthly economic report is likely to reflect some domestic weakness and waning export demand, which will only add to evidence that the Bank of Japan will be forced to continue with their liquidity measures at the behest of the government. Finally, the all-industry activity index is projected to rise a slight 0.1 percent for the month of November, though there are downside risks for this release given the dour state of consumer sentiment.

The other type of event risk to watch out for is related to US equities, as disappointing Q4 revenues from JPMorgan on Friday spurred concerns that other US banks will announce similar results next week. Major US banks like Citigroup, Bank of America, Wells Fargo, and Goldman Sachs are due to release earnings, and regardless of whether they are greater than or lower than expectations, equity, bond, and forex markets alike are sure to respond accordingly. Indeed, based on Friday’s rally in the Japanese yen and US dollar in response to worries about the financial sector, it seems as though risk aversion still has the potential to be a driving force. Furthermore, both COT positioning and FXCM’s Speculative Sentiment Index (SSI) suggest that a Japanese yen bottom could be in place, creating significant upside risks for the low-yielding currency.

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