Japanese Yen: Will Risk Flows Hold Up To A Severe Recession

The Japanese yen was one of the few currencies this past week to produce a consistent and aggressive move. Taking advantage of the unwinding of risky positions that were built up through most of March and April, the safe haven rallied 6.3 percent against the New Zealand dollar, 5.7 percent against the Australian currency and even managed a 3.3 percent advance against the greenback – the other safe haven currency. Looking ahead to next week, there will be two key, fundamental concerns for traders: the overall appetite for risk and the yen’s unwavering brand as the market’s harbor in uncertain seas.
The easier task is gauging the health of risk appetite. This past week, it was clear that optimism stalled. Without the threat of a major bank failure or shock to the credit market since the October market crash that followed the Lehman and AIG troubles, we have seen investors cautiously diversify away from risk-free assets like treasuries back into the more speculative asset classes like corporate bonds and equities. It is hard to miss the aggressive advance in key gauges like the Dow Jones Industrial Average and the DailyFX Carry Index . However, it is important to distinguish whether this is a rise in optimism or merely a return of investable funds to the market. In all likelihood, the bulk of this rebound can likely be attributed to capital finding its way back into the market in search of a competitive return. Investors wouldn’t attempt this if they were panicked; but if they believed the worst of the shocks are behind us, they would. However, this is different from a true rise in confidence where market participants have a major of their funds in the speculative arena and are trying to outpace the markets returns. With little hope for meaningful earnings, dividends, yields or capital returns through the rest of this year, traders will be standing with one foot out the door. All it will take is a possible financial crisis in the Euro Zone, US, UK, China or Japan and the whole world would reel in response.
While it is easy to determine the general level of sentiment in the market; it is a subtle and nuanced effort to measure an instrument’s relation to such a broad theme. Despite the significant deterioration in the Japanese economy over the past months, the yen has managed to retain its place as top refuge with few corrections. However, with each problem that arises from the Land of the Rising Sun (political, financial, economic), the less suited it seems for such a title. Indeed, we have to remember that this economy stagnated for more than a decade before this crisis as ill-conceived policy measures dampened a true recovery for the world’s second largest economy. Event risk over the coming days may feed such misgivings. Topping the list, is the preliminary revisions for the first quarter GDP readings. The initial 12.1 percent pace of contraction reported last month marked the worst slump since 1974. Should the plunge be revised down to 15.9 percent it would be the worst pace on record and likely signal a technical depression. Can an economy that is leading an economic malaise and will likely struggle to recover for years stand as a safe haven for capital? That is for the market to decide