USDJPY: US Dollar Japanese Yen Exchange Rate Forecast

[B]US Dollar / Japanese Yen Monthly Technical Forecast[/B]

Remains locked in a fairly intense downtrend and is currently in the process of attempting to carve out a fresh lower top below 110.70 (August 2008 high) by the 2009 highs from April at 101.45, ahead of the next downside extension below the historic trend lows from a few months back set at 87.15. The key level to watch below comes in by 91.75, with a break to accelerate declines and directly expose 87.15 further down. Back above falling trend-line resistance in the 98.00’s would however delay the bearish structure, while above 101.45 ultimately negates.

[B]US Dollar / Japanese Yen Interest Rate Forecast[/B]

Interest rate traders forecast that the US Dollar yield advantage over the Japanese Yen will pick up significantly in the coming 12 months, but recently apathetic FX speculators have shown little interest in interest rate developments. The US Dollar/Japanese Yen exchange rate has instead moved off of shifts in global financial risk sentiment—especially as seen through key risk barometers such as the S&P 500 and Nikkei 225 indices. We predict this will continue to be the case through the foreseeable future.

Indeed, Overnight Index Swap differentials have supported a USDJPY rally since the pair traded near the 105 mark. Suffice it to say, such interest rate-based forecasts were far from accurate. It remains far more important to monitor general financial market risk sentiment.

[B]US Dollar / Japanese Yen Valuation Forecast[/B]

The bottom line for the Japanese Yen is broadly unchanged for the fifth consecutive month with the currency still effectively at its “fair” value against the US Dollar. As before, both the yield outlook and comparative economic growth expectations are biased in favor of the greenback. Indeed, median estimates from a survey of economists conducted by Bloomberg suggest that US GDP growth will outpace that of Japan by an average of 2.4% through the end of 2010. The pair’s correlation to risk trends seems to have declined sharply recently, but these relationships can vary in prominence over time and there is certainly a possibility that any return to risk aversion would prompt carry trade liquidation and send the Yen higher across the board, weighing on USDJPY by association. On balance, current positioning does not offer an attractive mispricing to be exploited from a valuation standpoint; it seems prudent to remain flat for the time being until a cleaner disparity presents itself.
[B]
What is Purchasing Power Parity?[/B]

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 Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.