Fundamental Forecast for the Japanese Yen: Neutral

- Dollar and Yen Rise on Risk Aversion but Swiss Franc Outperforms
- U.S. Dollar, Japanese Yen Rise as Stocks Drop on China Growth Fears

The Japanese yen rallied against the U.S. dollar this week, finishing as the second best performing G10 currencies through Friday’s close as traders seek the safety of lower yielding currencies. The flight to safety witnessed by market participants this past week will likely maintain its course at a slower pace as the recent fundamental developments in Japan show that the economy may have stalled in May, while the European debt crisis continues to rattle the markets.

During this past week, Moody’s announced that it is placing Spain’s AAA rating on review for a downgrade. The decision by the rating agency was prompted by concerns over the impact of rising funding costs over the medium term and weakening economic growth prospects. Also fueling European concerns was a 132 billion euro 90 day LTRO followed by an additional bid for 111.2 billion euros in six day loans the subsequent day at the same rate as the 90 day notes. Why would banks accept additional funds due in six days rather than collect all of the capital needed via 90 day loans? The answer remains unknown. However, what is becoming apparent is that the liquidity crunch in Europe is as bad as most people have feared. The euro fell massively on Monday and Tuesday against the yen before a bout of risk appetite led price action higher to stall at the 20 day SMA. However, a round of disappointing data from the world’s third largest economy gave reason for losses against the euro during mid week trading.

Taking a look at the Japanese economic docket last week, retail sales fell for the first time this year, while the unemployment rate continued its northern journey. In addition, industrial production and household spending contracted for the month of May. All in all, this week’s data indicates that the recovery in Japan may have stalled in May. As for the upcoming week, the economic docket is expected to show the leading index fall to 98.9 from 101.7, while machine orders are forecasted to decline for the third time this year. In addition, the trade balance is surveyed to narrow to 478.1B yen from 859.1B yen. The leading index is especially important as these figures generally precede larger developments in the rest of the economy, and is thought to predict activity that will occur in 6 – 9 months. Expected decreases in machine orders will add to the dour employment outlook as reduces are indicative of low business confidence. Looking ahead, it may be too early for the Japanese government to withdraw fiscal stimulus measures as the wage-price deflationary cycle gains its footing.

With regards to price action, the Japanese yen may witness choppy price action to start next week as U.S. markets will be closed on Monday in observance of the U.S. Independence day holiday. However, with reference to the USDJPY, daily studies are showing that the pair is oversold after a massive sell off from a high of 89.48 to a low 86.96 this week. However, our speculative sentiment index which has been at extreme levels this week and accurately signaled for losses remains relatively unchanged as the index now stands at 4.64.

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