Fundamental Forecast for Japanese Yen: Bearish

The Japanese yen pared the decline from earlier this month, with the USD/JPY testing a low of 76.55, but the low-yielding currency may struggle to hold its ground over the following week as policy makers pledge to act against the marked appreciation in the exchange rate. Indeed, Bank of Japan board members Ryuzo Miyao and Sayuri Shirai said they would take the necessary steps to shore up the ailing economy, and the central bank may see scope to expand its credit and asset purchase programs as the remarkable strength in the local currency bears down on the real economy.

Speculation for a Yen intervention may also resurface as the USD/JPY approaches the post-World War II low of 75.95, and there could be an increased reliance on the BoJ to specifically target the exchange rate as Japanese Prime Minister Yoshihiko Noda calls for ‘resolute action.’ As the PM voices his concern about the ‘one-sided’ trade in the Japanese Yen, and the BoJ may face increased pressure to employ additional tools to shore up the economy as policy makers highlight the dampening effects of the local currency. However, the PM noted that the economy is expected to expand by more than 2% in the fiscal year beginning April 2012, and the central bank may carry its wait-and-see approach into the following year as the economic recovery is expected to gather pace.

At the same time, the FOMC interest rate decision could also heavily impact the Yen as the Fed discusses the prospects of selling short-term notes while purchasing longer-term bonds - known as Operation Twist – and an increase in short-term U.S. interest rates should help to normalize the exchange rate as higher yields increase the appeal of the dollar. Should the Fed take steps to flatten the yield curve, we may see the USD/JPY carve out a bottom in the week ahead, and the exchange rate may retrace the sharp decline from back in August (80.22) as market participants move away from the Yen.

DailyFX provides forex news on the economic reports and political events that influence the forex market.