Japanese Yen Shouldn’t be Strong, but it will likely Continue HigherJapanese Yen Shouldn’t be Strong, but it will likely Continue Higher

Fundamental Forecast for Yen:Bearish

The Japanese Yen finished the week sharply higher against most FX counterparts and remains the top-performing major world currency through 2016. Further market turmoil seems likely to push the risk-sensitive JPY to further highs despite clear risks to the Japanese economy, and indeed our focus is on stocks as the US S&P 500 and other global stalwarts continue recent losses.

There are some fairly clear fundamental reasons why the Japanese Yen should be weaker against the US Dollar and a handful of other currencies, but it likewise remains clear that sharp financial market turmoil will most often spark panic-driven JPY gains.

Recent CFTC Commitment of Traders data shows that large speculative futures traders bought aggressively into Yen strength and are now their most net-long (net-short USD/JPY) since it traded at ¥83 in October, 2012. It was only two months ago that the same group of traders was on aggregate near a record net-short JPY position (USD/JPY-long), and the dramatic turnaround underlines the severity of recent moves.

We believe that one of the biggest risks on the horizon is a substantive currency devaluation from China, while a significant repricing of Fed interest rate forecasts also seems inevitable. Both of these should in theory be bearish for the Japanese economy and by extension the Yen (bullish USD/JPY). And yet if either or both is accompanied with significant volatility across global markets, a broader flight to safety could once again drive Yen gains (USD/JPY declines).

It may be important to watch for major surprises out of upcoming Japanese CPI inflation figures, but the focus remains squarely on upcoming price action out of global equity markets. If we see further turmoil out of China at Sunday’s open, further contagion could drive turmoil in European and North American markets. And any such moves would likely fuel continued JPY strength across the board.