Fundamental Forecast for Japanese Yen: Bullish

- Japan’s Retail Service Demand Declines as Expected in November
- Consumer Confidence Drops for Second Month on Employment Outlook

The Japanese Yen is likely to extend gains, looking beyond a busy economic calendar to rise on safety-seeking capital flows as evaporating confidence across financial markets sends investors out of fleeing out of risky assets.

Friday’s closing bell marked the end of the worst three-day stretch for US equity markets since last year’s broad-based recovery in risk appetite began in March. The VIX index of stock option volatility, a standby “fear” gauge, surged 55% over the past three days to post the biggest gain since 2007. Investors had their pick of reasons to be selling: fourth-quarter earnings reports disappointed on revenues, which would have been overlooked last year but now is far more critical now that the end of stimulus measures is on the horizon and the economic recovery must become self-sufficient; US lawmakers dithered on whether Fed Chairman Ben Bernanke, a figure the markets view a key positive force amid the 2008 financial crisis, will be confirmed for a second term; US President Obama proposed wide-reaching new restrictions on banks’ size and trading activities; and stronger-than-expected Chinese GDP and inflation figures stoked speculation that Beijing would step up efforts to restrict lending amid fears the economy may overheat.

The widespread exodus from risky assets did not leave carry trades unscathed, pushing the Yen sharply higher against the spectrum of its major counterparts as investors sold high-yielding currencies covered their short positions in the low-yielding Japanese unit. With seemingly no easy resolution to any of the issues now weighing on investor confidence, more of the same is likely ahead. Indeed, the short-term correlation between a trade-weighted index of Yen’s value and the 10-year US Treasury note, the benchmark safe-haven instrument, now stands at 88% versus just 66% at the beginning of the week.

The economic calendar does not promise any significant deviations from established themes and seems unlikely to derail risk-driven trading. The monetary policy announcement from the Bank of Japan is unlikely to bring anything new beyond the now familiar warnings about deflation and the need to keep policy accommodative. December’s trade figures are expected to show that exports rose 7.3% from a year before, the first increase in the annual growth rate in 15 months, but year-on-year comparisons were invariably going to turn positive assuming anything shy of continued freefall when compared against the record-setting collapse in late 2008. The same can be said of December’s Retail Sales report, which is poised to show the first positive annualized reading in well over a year. Labor market and CPI figures round out the week, with an increase in the Jobless Rate and continued deflation all falling firmly in line with what has been priced into the Yen exchange rate.

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