Fundamental Forecast for Japanese Yen: Neutral

The Japanese yen outperformed last week, rising against all of its major counterparts on the coattails of a sharp drop in risk appetite amid fears that turmoil in the Middle East will push up oil prices such as to derail the global recovery. Interestingly, short-term correlation studies suggest the transmission of risk trends into the exchange rate seems to have followed a different channel usual.

Typically, the yen rises at times of stress as risk aversion spurs an unwinding of carry trades funded cheaply in the perennially low-yielding currency. This time around however, the story had more to do with US Treasury yields: rising jitters sent capital out of stocks (as well as other risk-geared assets) and into the safety of – among several favorite havens – US government debt. This drove up bond prices, sending yields sharply lower. A firm inverse correlation between a trade-weighted index of the yen’s average value and the long end of the US yield curve meant that it also translated into an impressive for the Japanese unit.

With this in mind, the coming week promises to be anything but quiet. While worries about the oil price may have calmed a bit after Saudi Arabia pledged to boost production to offset any Libyan-linked shortages, a packed docket of scheduled event risk promises to keep sentiment trends in flux. The US economic calendar alone is reason enough to expect dramatic price movement, with the ISM Manufacturing Survey, the Fed’s Beige Book and the all-important Nonfarm Payrolls report along with a hefty dollop of second-tier releases all due to cross the wires. A long list of Federal Reserve speakers – headlined by Chairman Bernanke’s semiannual congressional testimony – as well as with the possibility of renewed sovereign jitters in the Euro Zone as Portugal rolls over a tranche of debt while Spain and Belgium tap the markets threaten to compound. Taken together, this makes for a complicated landscape, with the likelihood of volatility seemingly the only firm conclusion to be made about the yen’s trajectory of the next five days.

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