The Japanese yen saw an exceptionally wild week of trading last week, rocketing more than 1 percent higher against most of the majors while tumbling almost 1.5 percent against the New Zealand dollar and Canadian dollar.
Fundamental Outlook for Japanese Yen: Bearish
- Japanese GDP contracts 2.4% in Q2, sparking recession fears as global growth slows - USD/JPY has thus far defied seasonality trends, but there is reason to believe the Japanese yen may still gain - Carry trades have been choppy, but there are still major Japanese Yen trading opportunities
The Japanese yen saw an exceptionally wild week of trading last week, rocketing more than 1 percent higher against most of the majors while tumbling almost 1.5 percent against the New Zealand dollar and Canadian dollar. What gives? First, there was a clear breakdown in carry trades, as volatility picked up, interest rate expectations across the majors shifted, and USD/JPY risk reversals fell. However, an important factor for the Japanese yen crosses in particular was the drop in interest rate expectations for the Bank of Japan. While overnight index swaps were only pricing in 5bps worth of rate hikes by the Bank of Japan over the next 12 months as of August 8, they are now pricing in absolutely no change as of August 15 and could contribute to Japanese yen declines going forward.
Of course, traders also need to keep in mind that a jump in risk aversion could trigger gains for the Japanese yen. Though our latest look at forex correlations shows a weakening in the link between the DJIA, USD/JPY, and G10 carry trades, it does not mean that the link cannot strengthen again. In fact, if we see that volatility in the greenback dies down next week and stops being the primary driver in the markets, attention could turn to the Japanese yen. There are two key pieces of event risk to watch: the BOJ’s policy meeting and Federal Reserve Chairman Ben Bernanke’s speech on financial stability (see the US dollar section for more). The BOJ is widely expected to leave rates steady at 0.50 percent, but if subsequent commentary sounds increasingly bearish on Japanese growth following last week’s 2.4 percent drop in GDP, the Japanese yen could subsequently sell off. However, Fed Chairman Bernanke’s commentary has the potential to have major repercussions for US equity markets, and if we see a stronger correlation between the DJIA and USD/JPY, the news could spark major gains for the ultimate low-yielder. – TB