Fundamental Forecast for Japanese Yen: Neutral

- Industrial Outputs Expand Less-Than-Expected
- Prime Minister Yukio Hatoyama Resigns
- Capital Spending Contracts in First Quarter
- Risk Aversion, Carry Unwind Stall as Traders Wait to See Whether NFPs, G20 Meeting will Revive Trend

The Japanese Yen bounced back on Friday following a shift in market sentiment, but the political uncertainties surrounding the world’s second largest economy could weigh on the exchange rate over the near-term as the Democratic Party of Japan’s Naoto Kan takes control of the government. However, as risk trends continue to dictate price action in the currency market, a rise in safe-haven flows would strengthen the Yen as investors scale back their appetite for risk. Meanwhile, Bank of Japan Governor Masaaki Shirakawa said that the “economy is making firm progress toward sustainable growth” as global trade picks up, but went onto say that the debt crisis could pose a threat if European policy makers fail to temper the risks for contagion.

After Mr. Hatoyama stepped down from his post earlier this week, former Finance Minister Kan was elected the new Prime Minister and pledged to “convince the public that real reforms are entering the stage of concrete implementation” as the economy struggles to shake off the recession. However, market participants anticipate that under the new leader, government efforts to temper the appreciation in the exchange rate will become a top priority in order to increase the competiveness of Japanese goods, and speculation for a currency intervention are likely to resurface going forward as Mr. Kan plans to work closely with the central bank and introduce “sweeping revenue reforms” in order to balance the risks for growth and inflation. Meanwhile, Bank of Japan board member Miyako Suda said “uncertainties has risen” as a result of the European debt crisis, and warned that the instability in the global financial market “could lead to a deterioration in corporate and household sentiment, hurting capital and consumer spending not only in Europe but Japan as well.” At the same time, Haruyuki Toyama, who heads the financial market department at the central bank, said that the BoJ’s JPY 20M commercial lending program “seems quite a success” as conditions improve, and policy makers may look to support the economy throughout the second-half of the year as the private sector remains weak.

Nevertheless, the economic docket for the following week is expected to show the trade surplus narrow to JPY 871.9B in April from JPY 1074.7 in the previous month as recent strength in the Japanese Yen weighs on foreign demands, while the preliminary reading for the leading index is forecasted to fall back to 102.5 during the same period from 102.7 in March. At the same time, the final GDP reading for the first quarter is anticipated to show the growth rate increase 1.0% during the first three-months of the year compared to an initial forecasts for a 1.2% expansion, while the GDP deflator, which acts as a broad gauge for inflation, is projected to decline at an annualized pace of 3.0%. As a result, market participants may raise expectations for further loosening in government policy, which could stoke expectations for the BoJ to introduce additional measures as the outlook for growth and inflation weakens.

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