The Japanese yen traded back to its multi year lows, hitting 123.73 against the greenback in overnight trade as Trade Balance data showed a far smaller surplus than originally forecast. The Japanese Merchandise Trade Balance printed at 389.5 Billion yen versus 462.7 Billion yen expected dropping to a four month low. The decline was driven by a sharp contraction of -12.9% in the surplus with US from the month prior and a -1.8% deficit with China as Japanese imports reached record highs despite the weak yen during May.

Overall the data was not as dour as the headline number would suggest with the trade balance rising 23.9% with Europe and 22.6% with Asia, but the markets were understandably rattled by the lackluster export growth to the US - Japan’s second largest customer – which expanded at a meager 0.4%. The slowdown in US consumer demand caused by the shake out in housing is clearly making it more difficult for Japanese exporters to generate sales growth in the region and presents yet another obstacle to BOJ policy makers who are looking for continued strong performance out of the export sector before raising Japanese short term rates. In short tonight’s data offered no solace to yen bulls and therefore after a small dip yesterday, USDJPY resumed its upward climb as yield differentials between the two countries continued to widen.

Yield played an important part in tonight’s EURUSD trade as well. Despite posting better than expected results in the flash PMI readings which printed at 57.7 versus 56.5 forecast, the euro lost ground against the greenback slipping to 1.3380 by the late morning in Europe. The PMI data was actually quite encouraging with the Manufacturing component rising to 55.4 and PMI Services hitting 58.3 which was the best read in over a year, however the market was focused on the bounce in US yields which spiked to 5.15% in overnight trade providing support for the dollar. Its difficult to determine what caused the fall in bonds prices overnight, but once source of concern could be the ongoing saga of the Bear Sterns hedge fund liquidation, which is weighing on investor sentiment as the underlying risks in that affair are far from transparent.

Tonight’s good EZ PMI data may be harbinger of stronger than expected IFO survey due early morning Friday and should offer a base of support for the EURUSD in the next 24 hours. However, with rising US bonds yields continuing to dominate order flow, economic reports could be relegated to the sidelines as the currency market continues to focus on the fluctuations in the US 10yr. bond.

Boris Schlossberg is a Senior Currency Strategist at FXCM.