Japanese Yen May Strengthen As Traders Seek Safety

Fundamental Forecast for the Japanese Yen: Bullish

- Japanese Yen Poised to Extend Gains as Risk Aversion Continues
- Japanese Yen Positioning Remains at Extreme Levels

The Japanese yen has pushed higher against the U.S. dollar last week, finishing 0.98 percent higher against the greenback through Friday’s close. For this upcoming week, we may continue to see the Japanese yen strengthen against most major currencies as investors continue to seek a flight to safety amid Europe’s debt woes and dovish comments from Fed officials.

During this past week, Federal Reserve Bank of St. Louis President James Bullard stated that the promise to keep interest rates at their record low for an “extended period of time” could have the counterproductive effect of encouraging a deflation trap similar to Japan. This statement trails Fed chairman Ben Bernanke semi-annual monetary policy testimony in which he stated that the economic outlook is “unusually uncertain.” Meanwhile, Europe’s debt woes continue to rattle the markets despite the recent ECB stress tests results which showed that 7 out of 91 banks failed. Interestingly, 6 out of 14 German banks failed to disclose their tests details, specifically the breakdown of their sovereign debt holdings.

Taking a look at the economic docket in the world’s third’s largest economy last week, housing starts advanced 0.6 percent, while small business confidence pushed higher. However, Japan’s unemployment rate unexpectedly increased for the fourth consecutive month, while industrial production posted its largest decline since February 2009. For this upcoming week, JPY traders will shift their focus to leading index which is expected to climb to 98.7 from 98.6. The leading index is of particular interest in that the reading tends to precede larger developments in the rest of the economy, and is thought to predict activity that will occur 6 – 9 months from the reported period (June).

With regards to price action, the USDJPY has extended its two day decline to reach the lowest level since November 30th. Looking ahead, the pair may continue to trend lower to test pivot support at 85.59. At the same time, it is noteworthy that our speculative sentiment index now stands at 5.34, signaling for further declines. However, investors should not rule out spite to the upside in the near term on the back of a possible BoJ FX intervention, which has been rumored in the markets recently. Conversely, a senior official of a panel of Japan’s ruling Democratic Party said that a strong yen should be dealt with not by currency invention but by further monetary easing. All in all, bias in the USDJPY remains to the downside in the short-term, however, investors should caution holding onto a short position for an extended period of time as a correction to the upside seems inevitable.

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