US Dollar Japanese Yen Exchange Rate Forecast

Everything from the 2009 low appears to be corrective. The 3 wave rally from 8480 is surely corrective, so there is the possibility that the USDJPY continues lower from here and takes out 8480. Favor the downside against 8690. A move above there would suggest additional bullish potential towards 8800-8900.

US Dollar / Japanese Yen Interest Rate Forecast

The spread between U.S. and Japanese interest rate expectations and the USD/JPY have been trending in the same direction which is attributable to the dimming outlook for the U.S. economy. The pair is traditionally linked with risk sentiment making it vulnerable to U.S. fundamental data evidence by its correlation with the 5yr treasury yield. Policy makers have pointed toward a weak labor market as a reason for keeping rates on hold which has broader markets looking for the Fed to remain on hold for at least the remainder of 2010.

The BoJ remains concerned with deflation despite signs that the economy is gaining traction making a rate hike nearly impossible. Overnight index swaps are pricing in zero basis points of tightening from the central bank which will most likely be the last of the G-7 to raise rates, negating the impact of the yield spread on price direction.

US Dollar / Japanese Yen Valuation Forecast

USDJPY Valuation Forecast: Bullish

The Yen is at its most overvalued since December 2008 as sagging US yields – a major driver of USDJPY since 1978, the first full year of the current floating exchange rate system after the demise of the Gold Standard – weigh heavily on the greenback’s value against its Japanese counterpart. This dynamic seems inherently temporary however considering the US needs to finance a record-high budget deficit, an outcome that is sure to put upward pressure on longer-term interest rates, while Federal Reserve policymakers are sure to begin hiking short-term borrowing costs faster than their deflation-plagued equals at the Bank of Japan. On balance, this suggests the current state of affairs presents a USDJPY buying opportunity, although the valuation gap may yet grow wider in the near term considering it is still relatively small at 9.1 percent.

What is Purchasing Power Parity?

One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.