Fundamental Forecast for Japanese Yen: Neutral

- Bank of Japan Maintains Dovish Posture, Hinting USDJPY Gains Ahead
- Japanese Service Demand Disappoints, Drops Most in Nine Months
- Fourth-Quarter Economic Growth Tops Expectations on Trade Rebound

The outlook for the Japanese Yen has become clouded as a likely recovery in risk appetite competes with currency traders backtracking on overdone US Federal Reserve rate hike expectations for control over near-term price action.

The Yen was the single worst-performing currency last week after losing a hefty 1.78 percent against the US Dollar, with selling initially set off by firmer risk appetite but truly encouraged after the US Federal Reserve unexpectedly hiked the discount lending rate. The announcement came just a day after the Bank of Japan reinforced their dovish posture against a backdrop of relatively hawkish minutes from the Fed’s late-January monetary policy meeting, which had already put upward pressure on USDJPY given the pair’s sensitivity to relative yield differentials. Traders looking for aggressive tightening out of the US central bank were disappointed by the end of the week however as January’s consumer price index figures broadly disappointed, with core inflation (excluding energy and food prices) issuing the first monthly decline in at least 13 years. This quickly stopped the USDJPY rally in its tracks as lackluster price growth deflated expectations that any significant tightening from the Fed was becoming imminent.

Looking ahead, the Yen is likely to find firmer footing at the start of the coming week as Asian traders have their chance to price in the US CPI result and unwind some of their long USDJPY positions. However, risk sentiment may return to the forefront as the primary driver of directional momentum for the Japanese unit. Indeed, the emergence of hawkish cues out of the Fed in the middle of last week disrupted an otherwise orderly correction in risk appetite as the debt problems in southern Europe faded into the background after the EU gave Athens until mid-March to show serious efforts in tackling its fiscal shortfall. Barring any unforeseen surprises, this process should now resume, boosting most of the majors at the expense of funding currencies (Dollar, Yen) as carry trades follow stocks higher.

The final outcome that the combination of these conflicting forces will produce for the Yen is unclear at this point. However, considering risky assets were on the way lower long before the Greek issue because the headline reason to be selling, a deeper upward correction now seems like a more lasting catalyst. If this proves accurate, the Yen is likely to move lower against all major currencies with the possible exception of USD, where relative monetary policy considerations between Japan and the States hold an arguably greater sway.

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