Fundamental Forecast for Japanese Yen: Neutral

- Japanese Large Manufacturer’s Survey Points to Jobless Recovery
- Bank of Japan Leaves Rates Unchanged, Doubles Bank Lending
- All Activity Index Outperforms in January on Service Sector Sales

Japanese Yen price action may remain indecisive for a second week against the US Dollar as the currency is pulled in opposing directions by its relationships with investors’ appetite for risky investments and the yields on US government debt. Sunday will see US lawmakers voting on legislation to overhaul America’s health-care system, a proposal that is projected to cost $940 billion dollars over the next 10 years by the Congressional Budget Office (CBO). The same projection also suggests that the measure – through various spending cuts and new revenue – will cut the fiscal deficit by $138 billion over the same period. However, the actual measure being voted on has been changed since the CBO’s assessment to help secure enough votes for passage. Further, even the previous cost/savings assessment assumes that Congress will actually do what it tells the CBO will be done, which is often not the case for politically unpopular things like excise taxes and reduced spending. On balance, the passage of the bill will likely create uncertainty about the degree to which it will compound the US’s already considerable fiscal shortfall. If markets perceive the headline CBO reading to be rosier than is realistic, long-term borrowing costs may see upward pressure on expectation that government will now need to issue more debt than previously expected. The short-term (20-day) correlation between USDJPY and the yield on benchmark 10-year US Treasury bonds stands at 0.72, hinting that such as outcome will pull the currency pair higher at least in the near term.

On the other hand, renewed escalation of the debt crisis in Greece has seen a return to risk aversion across financial markets. Greek PM George Papandreou has said that his country will be able to deal with their 2010 shortfall of 53 billion euros – 20 billion of which are needed by April and May – only if it is able to borrow on “reasonable” terms, otherwise turning to the IMF for help as a last resort. The comment was designed to prod the EU to offer something more concrete beyond broad statements of support for Greek austerity efforts, which have failed to meaningfully narrow the spread between the yields that Greece must pay to its lenders versus those required of Germany (the region’s benchmark). Policymakers will meet in Brussels next week to discuss a mechanism for offering Greece “coordinated bilateral loans” to stave off a default, calm markets, and bring down borrowing costs. However, reaching agreement will be all but impossible without support from Germany, the region’s top economy. Such support became suddenly remote last Thursday after an official inside the Berlin administration said that “in the case that the Greeks get into really serious problems, [Germany] would support an IMF solution.” Any involvement from the IMF would likely have negative implications for the EU and risk appetite at large, showing that the world’s largest economy is unable to keep its own house in order. This means that anything short of a decisive outcome in Brussels ought to bode ill for carry trades, a good deal of which are funded by borrowing cheaply in the Yen, meaning that any return to risk aversion is likely to put upward pressure on the Japanese unit as traders unwind their yield-seeking FX exposure.

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