Fundamental Forecast for the Japanese Yen: Neutral

The Japanese yen pushed higher against the U.S. dollar this week, climbing some 1.69 percent as developments in the world’s largest economy failed to meet market expectations. The rally in the yen is quite impressive due to the fact that the S&P slashed Japan’s rating to AA- from AA. Looking ahead, the USDJPY is unlikely to break out of its current triangle formation unless the economy gains momentum on the back of positive fundamental developments. Until then, traders should not rule out the yen benefiting from dollar weakness in the near term. The slew of risk scheduled for next week may provide color to the bleak picture.

For most of 2010, the yen was benefiting from its safe haven status amid uncertainty in the global economy, rather than developments in the region. The yen is considered a safe haven because the current account surplus reduces Japan’s dependence on borrowing from abroad. It is important to note and attribute the yen’s rally last year to its safe haven appeal because as the world’s largest economy stabilizes, the yen is expected to lose ground. As of late, the U.S. has yet to show these positive fundamentals. Annualized economic activity in the U.S. rose 3.2 percent in the fourth quarter amid economists’ forecasts of 3.5 percent. Though the headline number was a disappointment, the final sales of domestic product posted a 7.1 percent gain which marked the highest reading since 1984. The component bodes for the economy because it means that businesses are spending again. However, this component was not enough to push the USDJPY higher as durable goods missed predications in December, while employment remains subdued. Next week, market participants will be faced with the highly anticipated U.S. nonfarm payrolls report. A better than expected release could potentially lead the USDJPY to break out from its current level.

Taking a look at Japan’s developments, the Standard & Poor’s downgraded the country’s debt rating from AA to AA-, citing that the country is facing a debt burden of 11 trillion dollars. Meanwhile, the Bank of Japan is expected to keep borrowing costs between 0 and 0.10 percent as the recovery seems to be slowing. This may lead the central bank to play a bigger role in aiding the economy return to the road of recovery. Looking at the USDJPY, the pair seems to have worked its way into a triangle formation. Indeed, price action has been a bit choppy, thus, currency traders should stay on the sideline and wait for clearer developments.

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