Fundamental Forecast for Japanese Yen: Neutral

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The Japanese Yen continued to strengthen against the U.S. dollar amid growing speculation for another currency intervention, and the central bank may vote to expand monetary policy over the following week in an effort to stem the downside risks for the region. At the same time, the Bank of Japan may attempt to talk down the marked appreciation in the exchange rate as the USD/JPY works its way back towards the yearly low at 82.86, and comments from the central bank could spark increased volatility in the exchange rate as investors weigh the prospects for future policy.

After selling 2.12T yen last month, the central bank may turn to other alternatives to weaken the exchange rate in order to balance the risks for the ailing economy. The BoJ is widely expected to hold the benchmark interest rate at 0.10% on Tuesday and may look to expand its lending program given the ongoing slack within the real economy. Meanwhile, Prime Minister Naoto Kan said the government will “closely coordinate” with the central bank to stem the risks for deflation, and pledged to “take decisive measures as needed” to support the export-led recovery. Increased pressures by Japanese policy makers could lead the central bank to intervene in the currency market for a second time this year, but the exchange rate may continue to trend lower over the near-term as the bearish sentiment underlying the U.S. dollar carries into October.

As the USD/JPY pares the advance from the BoJ intervention and steadily pushes back towards 83.00, there could be another pop ahead of the rate decision as speculation for a currency intervention intensifies. Unless we get a clear signal from the central bank, a jump in the exchange rate driven by market speculation will be short lived as retail FX traders continue to look for an intervention. The DailyFX Speculative Sentiment Index for the USD/JPY stands at a whopping 7.2 going into the weekend, which suggests that the pair will continue to trend lower as traders are heavily net long, and we may see the exchange breech the yearly low as the dollar-yen maintains the downward trend from earlier this year. A break below 82.86 will certainly heighten expectations for a currency intervention, but we may see the BoJ refrain from selling its national currency and take a different approach to stem the marked appreciation in the exchange rate.

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