Fundamental Forecast for Japanese Yen: Neutral

- Consumer Prices Fell 1.3% in January as Deflation Continues to Reign
- Industrial Production Rose by 2.5%, Surpassing Expectations of 1.0%
- Yen Technical Outlook Points Toward Future Weakness

A week full of major event risk should put risk sentiment up for grabs which clouds the outlook for the Yen. The past week saw the Asian currency soar as the threat of another credit rating downgrade for Greece and the dimming outlook for global growth sparked a flight to safety. Markets remained concerned that the European nation’s troubles could become a contagion for the region and a threat to the global recovery. The theory that the economic region could decouple from the broader economy is beginning to be put forth, which is the same line of thinking that was prevalent before the credit crisis regarding the U.S.. If we start to see signs that growth is slowing and policy makers becoming cautious then a deeper sense of fear could emerge leading to continue yen support. Rate decisions from the RBA, BoC, and BoE; GDP figures from Canada and Australia combined with U.S. manufacturing, service and employment data will provide a great deal of insight into the prospects of global growth.

Japanese fundamentals are often overlooked in regards to determining price direction for the Yen. However, the Japanese economy is in such a fragile state that it could potential lose its status as a safe haven and therefore must be monitored. Consumer prices fell 1.3% in January as the country continues to find itself in a deflationary environment which supports the BoJ’s forecast that prices could decline until 2012. Until price growth returns then central bank will be force to leave rates at 0.10% solidifying the yen’s status as a funding currency. The pace of the decline in prices slowed from -1.7% and beat estimates for -1.4% which is a sign that the economy is beginning to move in the right direction. A 2.5% rise in industrial production and an unexpected gain in retail trade of 2.6% versus forecasts of -0.2% add to the improving picture for the economy. As long as the Japanese economy is moving away from the edge of a collapse and interest rates are expected to remain low then the Yen will maintain its negative correlation with risk appetite.

This week’s calendar is expected to show improvements in household spending and capital spending which will continue the theme of positive fundamentals. Regardless the Japanese economy is expected to lag several of its counterparts which have longer-term forecast pointing toward Yen weakness, as yield spreads are expected to widen. Signs that the world’s major economies are producing sustainable growth and policy makers are taking a hawkish bias could initiate an extended period of Yen weakness. However, most likely we will see a mixed bag and with the prevailing concerns over European sovereign debt, a week of volatility could leave most yen crosses close to where they started.

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