USDJPY Monthly Technical Forecast

2009.04 - forecast - jpy - 1

Bigger picture, “a 4th wave triangle (that took 12 years) is complete at 124.30 as a 4th wave and the US Dollar/Japanese Yen is headed lower in a 5th wave (and terminal thrust) that will end below 79.75. One possibility is that the US Dollar/Japanese Yen decline from 124.20 is unfolding as an ending diagonal.  The bottom line is that the USDJPY remains bearish longer term and an end to the advance is expected.  A line drawn off of the July 2007 and August 2008 highs is potential resistance at 103.30 this month.

US Dollar/Japanese Yen Interest Rate Forecast

2009.04 - forecast - jpy - 2

The spread in interest rate expectations between the dollar and the yen shrunk from 39 to 32 which was driven by a six point decline in U.S. expectations. The Japanese interest rate expectations remained virtually unchanged as the country has traditionally kept their interest rates low as they desire to keep their currency weak in order to foster increased demand for exports.  Indeed, it is this dependence on global demand which has sent its economy into the deepest recession of the developed countries.

However, from the graph above we can see that the interest rate outlook has had very little impact in 2009 on the pair’s price action which is primarily driven by risk appetite. However, if inflationary pressures increase then we may start to U.S. interest rate expectations rise which could increase the Yen’s status as a funding currency and lead the USD/JPY higher.

US Dollar – Japanese Yen Valuation Forecast

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The Japanese Yen is effectively at its “fair” value against the US Dollar. However, both the yield outlook and comparative economic growth expectations are biased in favor of the greenback. Indeed, the States are forecast to outpace Japan’s performance by 3.5% this year and 1.6% in 2010. This suggests a broadly bullish bias for USDJPY in the week and months ahead, making a trade at current levels unattractive from a valuation standpoint. We remain flat for the time being until a cleaner mispricing presents itself.

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 pairs that are undervalued against their PPP exchange rate have the size of the value gap denoted in RED, while those that are overvalued are denoted in GREEN.