In our last commentary on the Japanese yen, we wrote that the currency was looking excessively weak against the euro. In particular, we stated that bullish catalysts driving EUR/JPY were at risk as speculator positioning in both long euro and short yen trades were looking extreme. In addition, we flagged changes to the Bank of Japan's “yield curve control” program as a potential risk for yen strength. While the BoJ has (predictably) resisted ending its quantitative easing efforts, we contended that even small changes to future guidance would push up the yen. While EUR/JPY traded around 136 when we published our last piece, the pair is trading closer to 130 today.
Looking at recent history, the yen strengthened during the first quarter of this year when risk-taking behavior became excessive. At the time, the US dollar sold off sharply as riskier assets such as commodities, the euro and equities all surged in response. In more recent history, the yen has entered a bearish trend. Between a diminished outlook for Eurozone growth and an ongoing slowdown in emerging markets, speculators are less keen to aggressively chase riskier investments. Given the yen's safe haven qualities (the currency weakens during booms and strengthens during downturns), this raises an obvious question: why is the yen weakening despite falling risk sentiment?
Yen bears will argue that the currency is trading as an inflation proxy, pointing to rising inflation expectations as the culprit for recent and ongoing weakness. Bulls will argue that recent yen weakness is more a function of the big move up in the US dollar, and is temporary in nature. While our trending indicators continue to suggest a bearish outlook for the yen, we ultimately side with the bulls. Later this quarter, we expect an ongoing deterioration in risk sentiment to push up the yen. Specifically, the yen is likely to strengthen thanks to an (1) ongoing slowdown in global growth, (2) a peak in US growth, and (3) a significant deterioration in the outlook for emerging markets.
