Fundamental Forecast for Japanese Yen: Bearish

The Japanese yen lost ground after advancing to a fresh record-high during the previous week, and the low-yielding currency may weaken further as policy maker step up their efforts to stem the marked appreciation in the exchange rate. Indeed, Japan Finance Minister Yoshihiko Noda introduced a $100B program to help businesses deal with the ongoing strength in the local currency, and there could be increased pressures on the Bank of Japan to intervene in the foreign exchange market as Moody’s downgrades the region’s credit rating by a notch to Aa3.

In response, BoJ Governor Masaaki Shirakawa retained his pledge to carefully monitor the Yen while speak to policy makers earlier this week, and went onto say that the central bank can implement additional monetary tools to balance the risks for the region should the exchange rate pose a greater risk to the economy. The increased reliance on the central bank may lead the board to take additional steps to dampen demands for the low-yielding currency, and the BoJ may look to increase its asset purchases further rather than stepping directly into the currency market. At the same time, the election scheduled for August 29 will also come into focus as the Democratic Party of Japan looks for Prime Minister Naoto Kan’s replacement, and the transition could derail confidence in the government’s ability to address the risks surrounding the region as policy makers come under increased scrutiny. In turn, the central bank may have little choice but to step up its efforts to shore up the economy, and we may hear the BoJ announce additional measures next month as the region struggles to recovery from the devastating earthquake/tsunami from earlier this year.

In turn, the near-term rebound in the USD/JPY may gather pace in the week ahead, and the exchange rate may continue to retrace the sharp decline from earlier this month as the fundamental outlook for Japan deteriorates. However, the Japanese may outperform against its major counterparts should carry interest falter, while the dollar-yen may give back the advance from 75.94 as market participants continue to diversify away from the reserve currency.

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