Japanese Yen at the Heart of QE3 Debate, US Data and Bernanke in Focus

Fundamental Forecast for Japanese Yen: Bearish

• Short Yen Position Favored vs. US Dollar as Range Persists
• Speculative Sentiment Suggests Yen Outlook Still Bullish
• Bank of Japan Reshuffles Stimulus Funds, Withholds Expansion
• Yen Continues to Show Strong Link to US Treasury Yields

The Japanese Yen remains firmly anchored to US Treasury yields, with both the benchmark USDJPY exchange rate and the broader Dow Jones FXCM Yen Index – an average of the currency’s value against its top counterparts – showing strong correlations with the return on the 10-year note. That puts the evolution of traders’ expectations off additional stimulus from the Federal Reserve front and center as the key driver of price action, with the week ahead offering plenty of event risk to stoke volatility.

On the US data front, the first batch of July’s economic activity surveys is due to come across the wires, with the Empire Manufacturing gauge of factory-sector performance in New York State and the Philadelphia Fed measure of business confidence on tap. Improvements are expected on both fronts, which may further dent QE3 bets after last week’s disappointing set of FOMC minutes, offering support to yields and weighing on the Yen.

The Fed’s Beige Book survey of regional economic conditions is likewise on deck and will probably be interpreted with the same underlying logic. Data from Credit Suisse shows US economic data stabilizing relative to expectations over the past three weeks. If the same tone carries through in the Fed’s report, stimulus hopes are likely to be scattered further to the detriment of the Japanese unit. June’s US CPI data rounds out big-ticket event risk. If the reading mirrors the sharp upside surprise of Friday’s PPI result, further accommodation will appear even more distant.

Looking beyond the packed docket of data releases, Federal Reserve Chairman Ben Bernanke will enter the spotlight as he delivers his semi-annual testimony to the US Congress. The outing is unlikely to bring much new information to the forefront: the central bank chief will leave the door open to additional easing in the event that the recovery materially falters – a now-familiar yarn meant to mollify jittery markets just enough to avoid pandemonium without actually expanding the balance sheet – while staying mum on specifics and admonishing the precarious fiscal situation. Traders continue to hold out hope for a hint of dovish rhetoric all the same however, meaning a status-quo outing can carry a Yen-negative connotation.

Importantly, the risk sentiment landscape is not altogether out of focus considering the Yen remains a beneficiary of haven flows linked both to the currency’s own merits as a highly liquid asset with attractive store-of-value parameters (courtesy of a deflationary economy) as well as downward pressure on bond yields at times of risk aversion. The second-quarter corporate earnings reporting season kicks into high gear next week with a whopping 92 members of the S&P 500 due to report results. Traders will pay particular attention to guidance for the coming quarters, which may stoke global slowdown fears and fuel risk-off trade. Eurozone finance ministers are also due to meet on Thursday to finalize Spain’s banking sector bailout, with policymakers aiming to deliver the first €30 billion in aid by the end of the month.