Fundamental Forecast for Japanese Yen: Bullish

-- Yen Soars as Japanese GDP Disappoints, Sinking Risk Appetite
-- Speculative Sentiment Points to Yen Gains vs Dollar, Pound
-- Technical Positioning Hints US Dollar Breakout vs Japanese Yen

Risk sentiment remains the dominant catalyst for the Yen, with prices tracking closely in line with the perennial safety asset – the US Treasury bond. Indeed, the correlation between a trade-weighted index of the Japanese currency’s average value against a basket of its major counterparts and the 2-year note stands at 0.78 – the highest in three months – on 20-day percent change studies. The relationship makes sense considering carry trades – yield-harvesting bets in favor of currencies attached to countries with high borrowing costs – tend to be financed in the perennially low-yield Yen. At times of risk aversion, these positions are unwound along with losses in other assets seen as representing a preference for return over safety, including stocks and commodities, leading JPY higher.

On balance, this puts the onus on US economic data as traders continue to look to the health of the world’s largest consumer market as the bellwether of the global recovery at large, particularly as other engines of worldwide growth increasingly falter. Indeed, Europe has been sidelined as the region tries to unwind its sovereign debt burden, Japan remains in deflation (which is expected to deepen again in July after two months of moderation), and China is willfully putting on the brakes amid fears of asset bubbles and runaway inflation.

Sizing up the US economic calendar, the path of least resistance points to continued risk aversion in the week ahead. The spotlight falls on the second revision of second-quarter US GDP figures, with the number expected to show that the annual growth rate slowed to 1.4 percent in the three months through June, the slowest in two years. Meanwhile, Existing Home Sales are set to drop 12.9 percent in July – the most in six months – while New Home Sales continue to hover at three-decade lows. Durable Goods Orders offer a bit of good news, with forecasts pointing to a 3 percent increase in July following two consecutive months of losses, but this release in isolation is unlikely to prove sufficient to stem the tide of risk aversion in and of itself.

All things considered, this suggests the Japanese Yen is likely to extend its already formidable five-week winning streak as stock markets lead the spectrum of risky assets lower, boosting demand for the safety-linked currency.

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