Fundamental Forecast for the Japanese Yen: Neutral

The Japanese yen crept higher against the U.S. dollar and the low-yielding currency may continue to appreciate against the greenback next week as we expect the Fed to maintain a cautious outlook for the world’s largest economy. As the USD/JPY remains capped by the 23.6% Fibonacci retracement from 2010 high to low around 83.50-70, the exchange rate may continue to pare the rebound from the beginning of January, and the dollar-yen could fall back towards 81.00 as market participants speculate the FOMC to ease monetary policy further this year.

In turn, a further appreciation in the Japanese currency could reignite speculation for a currency intervention as the Bank of Japan struggles to stem the risk for deflation, and the dollar-yen may consolidate over the near-term as investors weigh the outlook for future policy. However, Japan’s Economic and Fiscal Policy Minister Kaoru Yosano said that the BoJ has “done pretty much all it can do” to curb the downside risks for the region and the central bank may continue to weigh different alternatives to stimulate the ailing economy as growth and inflation remains subdued. The BoJ is widely expected to maintain its current policy next week, but the central bank may raise its economic assessment as its chief economist, Kazuo Momma, expects the recovery to gather pace in the first-half of 2011. Mr. Momma said that the economy will “emerge from a lull and start to resume a moderate recovery” while speaking earlier this week, and the central bank may adopt a wait-and-see approach for the first-quarter as growth prospects improve.

Meanwhile, the Fed may continue to casts doubts for a sustainable recovery in the U.S. given the ongoing weakness within the private sector, and dovish comments from the central bank could dampen yield expectations as fear surrounding the economic outlook bears down on market sentiment. As a result, the BoJ and the FOMC interest rate decisions could generate a bullish reaction in the Japanese Yen, and price action may push lower going into the following month as the USD/JPY carves a lower top in January.

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