Despite the more than 2% decline in Shanghai the yen continued to flounder ahead of the NFP report today, as carry trade pressure saw no signs of abating. Yen bulls started the week on a promising note as employment and spending data showed improvement. However, as the week progressed the economic news from Japan grew more dreary, With labor cash earnings registering their fifth consecutive month of contraction. In short all of the optimism on Monday was stamped out by Friday, with traders coming to the conclusion that rates in Japan will remain stationary for the foreseeable future. Trading in the yen even decoupled from the usual risk aversion dynamics as market participants shrugged off the overnight decline in Chinese stocks.

It’s difficult to say what will bring the bid back into the yen at this point. Certainly Japanese data has been of no help and until and unless global growth slows down to such an extent that market foresees no additional rate hikes from the G-7 universe, the yen appears to be in a free fall. However, that having been said, at 122.00 USD/JPY is approaching grossly overbought territory and with market positioning so heavily skewed towards the carry, the risks to the longs in that trade increase substantially, especially if there is a sudden shift in sentiment regarding the prospects of global growth.

Today, the currency market will get a much better idea as to those prospects when the NFP report is released at 12:30 GMT. As wonted in our preview yesterday, “In all likelihood the May numbers should print in the neighborhood of 100K. However the revisions from the month prior may serve as a tipping point. An upward revision would eliminate much of the concern about the recession scenario in H2 of 2007 and would most likely put a bid underneath the greenback. However a downward revision off the already weak 88K print last month would be quite bearish for the dollar and put the EURUSD on a path to retest its recent highs.”

Boris Schlossberg is a Senior Currency Strategist at FXCM.