jpy fundamentals

US Dollar/Japanese Yen Exchange Rate Forecast

Wednesday, 26 November 2008 16:02:38 GMT  |  Jamie Saettele, Senior Strategist; David Rodriguez, Quantitative Analyst; Ilya Spivak, Currency Analyst

USDJPY Long-Term Technical Forecast

No change since last month: This is a chart that we have focused on time and time again. A 4th wave triangle (that took 12 years) is complete at 124.13 as a 4th wave and the USDJPY is headed lower in a 5th wave (and terminal thrust) that will end below 81.12. The underside of the lower line of the triangle was tested as resistance at 110.65 last month. This is viewed as the top of corrective wave 2. 

New: Staying below 110.65 keeps the larger trend down.  Be sure to check the Daily Technicals every day, since risk levels are constantly updated.  At this point, bears should keep risk to 98.31.  A move above there suggests bullish potential to the 102.50-103.10 zone before resumption of the larger downtrend.

USD/JPY Fundamental Outlook/Interest Rate Forecast

Japanese Yen interest rate expectations have had virtually zero impact on the US Dollar/Japanese Yen exchange rate, and instead we see that USD/JPY forecasts will depend on broader outlook for financial market conditions. During times of financial market difficulty, currency speculators will most often buy the Japanese Yen against major forex counterparts. Exceedingly low interest domestic interest rates have made the Japanese Yen a major source of cheap funding for speculative bets across world financial markets. Forex speculators often borrowed Yen to subsequently buy higher-yielding counterparts, but continued financial market distress has made these bets a recipe for disaster as deleveraging forces many traders to unwind previous Japanese Yen sorts.

That being said, we will almost certainly continue to see the Japanese Yen trade off of global financial market conditions and risk sentiment. If the ongoing crisis worsens, we could easily see the Japanese Yen rally further against the similarly resurgent US Dollar.

US Dollar/Japanese Yen Valuation Forecast

USDJPY Valuation Forecast: Bullish

The flight to safety that has brought on a sharp unwinding of the carry trade has seen the Japanese Yen become profoundly overvalued against the US Dollar. While the pair’s most recent patterns suggest that continued pain in the stock market will continue pushing it lower, it does stand to reason that at some point the sharp deleveraging we have seen will find a floor and the fundamentals will take over to erode the correlation between forex and equities. As this occurs, the dire state of the Japanese economy and its likelihood to lag in the recovery behind that of the US (for surely Japanese authorities have not been as aggressive or creative in tackling the problem as their American counterparts) have scope to send USDJPY higher.

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 the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.

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