Fundamental Forecast for the Japanese Yen:Mixed

The outlook for the Japanese Yen continues to depend heavily on the currency pairing in question, with the crosses continuing to show a strong sensitivity to broad-based market sentiment trends while the benchmark USDJPY is distorted by intervention risk. In either case however, the principal consideration for the week ahead is the severity of Eurozone sovereign stress and investors’ resulting demand for the Yen as a safe haven.

As we have argued on numerous occasions, the Yen fulfills both critical characteristics of an attractive safe-haven asset. It is the world’s third-most traded currency (according to data from the BIS), making abundantly liquid and thereby a compelling place to park capital at times of crisis because retrieving it is relatively easy once the storm passes and reallocation to higher-yielding investments is desired. It is also an excellent store of value courtesy of Japan’s anemic inflation rate. In fact, headline year-on-year CPI has been sinking deeper into negative territory over the past three months.

Whether these qualities will prove desirable over the coming days depends largely on the news-flow out of the Eurozone. Political efforts to reassure the markets have clearly stalled, with the average yield on benchmark 10-year bonds from the so-called “PIIGS” countries – the Eurozone members most afflicted by sovereign risk concerns – finishing last week just a hair below record highs. Needless to say this reflects the markets’ demand for a considerable risk premium tacked onto borrowing costs, speaking of extreme reluctance to lend to the likes of Italy and Spain.

The conversation is noticeably shifting to the role of the ECB in containing the crisis, with calls for a large-scale QE program growing ever-louder in some parts of the currency bloc and across financial markets while meeting stiff resistance in Germany and seemingly at the central bank itself. Indeed, comments from newly-minted ECB President Mario Draghi on Friday bemoaning a potential loss of ECB credibility seemed to allude that he is partial to the German view of a narrow mandate focusing on inflation for the central bank.

However, harping on price stability while warning of mounting risks to growth may reflect a strategy to rationalize larger bond purchases without appearing to bail out governments, framing the argument for QE as a bulwark against deflationary pressures. If such a narrative begins to emerge, it is likely to boost confidence in the short term and weigh broadly on the Yen against the spectrum of its counterparts. Otherwise, continued refusal to help tame soaring borrowing costs is likely to push the Japanese currency higher against most of its top counterparts. In the case of USDJPY specifically, it may also signal oncoming intervention if prices probe below the 76.00 figure once again. - IS