Fundamental Forecast for Japanese Yen: Neutral

The Japanese yen struggled to hold its ground against the greenback as yields tied to U.S. Treasuries pared the decline from earlier this month, but the USD/JPY could be heavily influenced by the event risks on tap for the following week as the world’s third-largest economy faces a risk for a double-dip recession. The advanced 1Q GDP report is expected to show the growth rate shrinking another 0.5% following the 0.3% contraction during the last three-months of 2010, and the development is likely to bear down on the outlook for global growth as the region copes with the slew of natural disasters from March and April.

With the Bank of Japan scheduled to hold its policy meeting next week, the board may step up its efforts to support the real economy and expand monetary policy further in an effort to stem the downside risks for the region. However, central bank head Masaaki Shirakawa may continue to endorse a wait-and-see approach after rejecting Deputy Governor Kiyohiko Nishimura’s proposal to increase the asset purchase program by another 5 trillion back in April, and the majority of the BoJ may vote to preserve its current policy over the coming months in order to better assess the current situation of the real economy. At the same time, the central bank may call for international assistance to stem the recent appreciation in the Japanese Yen, and speculation for another coordination intervention may resurface if the dollar-yen continues to approach 76.31, the lowest exchange rate see since the post-war period. In turn, the rebound from the month low (79.56) may gather pace over the following week, and the U.S. dollar may gain ground against its low-yielding counterpart over the remainder of the month as the Federal Reserve looks to conclude its easing cycle in June.

As the FOMC policy meeting minutes are due out on May 18, the statement is likely to spark increased volatility in the USD/JPY as investors weigh the prospects for future policy, and the central bank may show a greater willingness to start normalizing monetary policy in the second-half of the year as the recovery in the world’s largest economy gathers pace. However, Fed Chairman Ben Bernanke may continue to talk down speculation for higher borrowing costs in the U.S. as he highlights the ongoing weakness within the private sector, and the committee may retain a zero interest rate policy for most of 2011 in an effort to balance the risks for the region. In turn, we should see the USD/JPY maintain its relationship with U.S. yields, and the exchange rate may face range-bound price action in the days ahead as it fails to push back above former support around 81.50.

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