Fundamental Forecast for Japanese Yen: Neutral
The Japanese Yen was the second best performer this week, trailing only the US Dollar by -0.18%, while posting ‘rebound’ gains against the rest of the majors, especially the Australian and New Zealand Dollars, and the Euro. If anything, this week was reminiscent of times past, when general anxiety and fear drove market participants into lower yielding currencies – the safe havens – regardless of the policies employed by the central banks behind those currencies.
This week was very much of this vein: Shinzo Abe nominated Asian Development Bank President Haruhiko Kuroda to be the next governor of the Bank of Japan – Mr. Kuroda has previously said before that the USDJPY exchange rate at ¥120 was too weak, which implies he may hold a similar sentiment now as the USDJPY trades near ¥93. His potential and likely confirmation should jumpstart the next round of Yen weakness, but that reaction to his nomination was absent this week solely because of rising political concerns in Europe and in the United States. While the economic calendar has some significant events on it, we choose to mostly overlook them as global markets are experiencing higher levels of volatility, and FX is realigning towards the ‘risk-on/risk-off’ landscape we witnessed for much of the past four years.
To quickly review the upcoming data, all of which that is significant coming out on Thursday: there is a Bank of Japan Rate Decision, but no new measures are likely to be announced at present time, until Masaaki Shirakawa steps down as governor and Mr. Kuroda fills his shoes; the preliminary January Leading Index should show a slight increase to 96.1 from 93.4, reflecting upbeat economic expectations going forward, which is of little surprise considering the expansive fiscal and monetary stimulus being fed to the market currently; the revised 4Q’12 GDP figures aren’t expected to show much of a change at all, relegating what is usually a key release to the secondary-tier; and the January Trade Balance (Balance of Payments basis) is expected to show a significant deficit at -¥1.512T from -¥567.6B in December, a testament to the negative effects of a weak currency – high energy import costs. The trade data is likely to spark the biggest reaction, but even so, the calendar is overall light.
Truly, sentiment surrounding the Italian election and the US budget sequestration (just a few hours away now, as this article is being penned) will dictate whether the Japanese Yen continues its modest rebound. The Italian situation needs no explanation once a chart of the EURJPY is examined – the pair fell by six (!) big figures on Monday once it became clear that the Italian parliament would be divided, or “hung.” The reason why this is weighing on investor sentiment is now it means either: another caretaker government under Mario Monti, who has grown increasingly unpopular amid heightened austerity and record high unemployment; or new elections in a few months (a national unity government would be very weak). The only difference between the reaction to the Italian elections and the French and Greek elections last May is now the European Central Bank has its OMT safety net in place to catch plummeting Italian and Spanish bonds. Continued political uncertainty could force Italy into accepting the terms of the OMT, in order to calm investors. Accordingly, a EURJPY pullback is likely to be more gradual, should it occur as it becomes clearer that the government is paralyzed.
The US budget sequestration is a bit trickier. US equity markets continue to linger within sight of all-time highs, and US Treasury yields remain relatively elevated from their lower levels seen within the past year. With the $85B cut literally around the corner, you wouldn’t have known it existed if you stuck to the charts; no one – not in FX, not in bonds, not in equities – seems to care. We’re a bit more cautious. The USDJPY has tracked the 2s10s Treasury spread very closely since November 15, which makes sense – rising US yields boost the US Dollar, especially against currencies whose central bank is employing ZIRP. But the 2s10s spread has fallen despite the continued rally in equity markets, and the elevation in the USDJPY – as history has showed us before, this divergence portends to risk-aversion on the horizon. Because it is hard to quantify investor sentiment regarding these major factors, we must hold a neutral bias on the Yen this week. -CV