Yen Support Could Fade With Continued Strength in Equities

USD/JPY

The yen regained its footing in late trading as equity markets gave back earlier gains. Caution remains in the air with the outlook for growth dimming and the troubles in Europe. A week of major event risk is ahead which could lead to wild fluctuations in risk sentiment and the yen as well. The Asian currency has seen its correlation with risk grow as traders have started to favor the yen over the dollar as a funding source for riskier investments. Equity markets are currently explaining 48% of volatility for the USD/JPY which is more than doubled from 20% a month ago. U.S. interest rate expectations also have a significant influence on price action as rising US yields would bring an end to the dollar’s status as a funding currency.  

 BoJ Interest Rate Expectations

Overnight Index Swaps are pricing a 1 bps of tightening over the next twelve months from the BoJ. Consumer prices fell 1.3% in January signaling that the country remain in a deflationary period which will make it formidable for the central bank to raise rates. The pace of deflation has slowed and the economy has shown signs of improving with retail trade and industrial production surpassing estimates. However, policy makers favor a low interest rate environment even in a growing economy as a weak yen fosters demand for exports.  To discuss this and trading ideas join the USD/JPY forum.

FOMC Interest Rate Expectations

An upward revision to 4Q GDP to 5.9% from 5.7% failed to raise the outlook for U.S. interest rates, as Fund Fed futures are only pricing in a 10.1% chance of a rate hike by June. A rise in initial jobless claims last week to 496,000 from 474,000 the week prior has fueled concerns that the economy is headed for a jobless recovery. This will put the focus on the upcoming Non-farm payroll report due out next Friday. Another month of negative employment will push out further the horizon for Fed tightening which will maintain the dollar as a funding source. 

Risk

Equity markets continued to rise from trendline support as an upward revision in U.S. GDP helped reinforced the notion that the credit crisis is over and growth is returning. However, the blue chip index struggled to hold onto to the majority of its gains to end the day slightly higher. The Dow’s current upward trending channel could foretell of additional gains if it holds true, but with the level of upcoming event risk the possibility of a breakout exists. The expectations that the economy lost jobs in February favors an increase in risk appetite and continued yen support.   Discuss this and other fundamental data join the Economics Forum. 

 To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com