Fundamental Forecast for the Japanese Yen: Neutral

- Bank of Japan Members See Rising Inflation Expectations, Minutes Show
- Japan’s Service Demand Rises for First in Three Months, Outlook Clouded
- Japanese Yen Short Entry Sought on a Move Below 90.00 vs US Dollar

The Japanese Yen outlook looks clouded as the currency re-couples with broad trends in risk sentiment even as confidence is pulled in opposing directions by the EU debt crisis and US economic data.

The replacement of Prime Minister Hatoyama with Naoto Kan has muted concerns about Japan’s political landscape, opening the door for the Yen to fall back in line with risk sentiment. Indeed, the 21-day percent change correlation between a trade-weighted average of the Japanese currency’s value against its top counterparts and the MSCI World Stock Index now stands at a hefty 0.82. This leaves the Yen at the mercy of broad trends in risk sentiment, putting the onus on a busy US economic calendar as well as developments linked to the EU debt crisis.

Looking first at the US data docket, the FOMC interest rate decision stands out as the top item of significance. Futures and overnight index swaps both reflect that traders price in no change in benchmark borrowing costs, but a gauge of longer-term expectations show the Fed is expected to tighten by a meager 34 basis points over the next 12 months, the lowest reading in a year. This hints that markets are overwhelmingly skewed toward favoring a static monetary policy for the foreseeable future, leaving the door open for broad-based volatility should the statement accompanying the announcement present any meaningful changes to the consensus outlook. Elsewhere on the docket, a heavy dollop of second-tier releases points to deteriorating conditions in the world’s largest consumer market. Existing Home Sales are set to post the smallest increase in three months while New Home Sales drop 18.7 percent – the most since January 1994. Meanwhile, Durable Goods Orders are expected to decline for the first time in six months, slipping 1.3 percent. The health of the US economy remains a proxy for that of the world at large, so all in all, the path of least resistance seems to be toward risk aversion.

Turning to Europe, the debt crisis has been the poster-child of risk aversion for some time so there is considerable overlap between internal EU developments and those driving overall investor confidence. While it seems generally accepted at this stage that financing gaping deficits will drive up borrowing costs and weigh on economic growth, this has likely made it into the exchange rate. This suggests that absent the emergence of an unforeseen, near-term risk factor on the horizon, there is some room to unwind bets against the region to relieve oversold conditions. Naturally, this works to buoy risk appetite, weighing against negative cues from the US calendar noted above.

DailyFX provides forex news on the economic reports and political events that influence the forex market.