Forex Analysis: Yen Poised to Extend Overnight Gains on Risk Aversion

By Ilya Spivak, Currency Strategist

The Japanese Yen appears poised to extend a recovery started at the open of the trading week as risk aversion grips financial markets anew.

Talking Points

• Japanese Yen Outperforms in Asia, More of the Same Likely This Week
• Australian, Canadian Dollars Vulnerable on Returning Risk Aversion
• Soft Eurozone PPI May Weigh on Euro Ahead of ECB Policy Decision

The Japanese Yen outperformed in overnight trade as Asian stocks declined, driving demand for safety-linked currencies. The MSCI Asia Pacific equity index fell 0.3 percent. The newswires attributed the move to profit-taking after the benchmark regional gauge hit a 17-month high last week.

Broadly speaking, a short lull in headline-driving event risk will give financial markets an opportunity for some reflection in the week ahead.The most significant lingering uncertainty over the coming months remains the outlook for US economic growth and there is much to consider in the aftermath of last week’s volatility

On one hand, risk appetite reacted favorably to a last-minute agreement averting the so-called “fiscal cliff”, but the reaction seemed overdone. While the smaller-scale tax hike baked into the accord is preferable to a far larger and broader increase that would have been triggered without a deal, it is nonetheless a headwind from an economic growth perspective.

Meanwhile, fears of an early end to the Fed’s stimulus efforts after the release of minutes from December’s FOMC sit-down seem likewise overblown. The adoption of the “Evans rule” linking rates to explicit inflation and unemployment targets was already mildly hawkish in that it set a firm exit strategy. However, even if the Fed halts asset purchases by mid-year, it will expand its balance sheet by close to $0.5 trillion.

On balance, the fiscal side of the equation seems to carry a greater degree of near-term uncertainty than the monetary one. That suggests the path of least resistance likely favors risk aversion. Near-term correlation studies suggest such a scenario is likely to prove most damaging for the Australian and Canadian Dollars while producing outsize gains for the Yen.

The economic calendar is relatively quiet in European hours. November’s Eurozone PPI figures are expected to put the year-on-year wholesale inflation rate at 2.4 percent, the lowest in four months. A particularly soft reading may weigh on the Euro ahead of this week’s ECB monetary policy announcement.

Asia Session: What Happened

GMT	CCY	EVENT	ACT	EXP	PREV
23:50	JPY	Monetary Base (YoY) (NOV)	11.8%	-	5.0%
23:50	JPY	Loans & Discounts Corp (YoY) (DEC)	0.44%	-	0.26%
0:01	GBP	Lloyds Employment Confidence (DEC)	-42	-	-42
5:00	JPY	Vehicle Sales (YoY) (DEC)	-3.4%	-	-3.3%

Euro Session: What to Expect

GMT	CCY	EVENT	EXP	PREV	IMPACT
8:00	GBP	Halifax House Prices sa (MoM) (DEC)	0.0%	1.0%	Low
8:00	GBP	Halifax House Prices 3Mths/Year (DEC)	-0.6%	-1.3%	Low
8:00	CHF	Foreign Currency Reserves (DEC)	423.0B	427.4B	Low
9:30	EUR	Euro Zone Sentix Investor Confidence (JAN)	-14.2	-16.8	Low
10:00	EUR	Euro Zone PPI (YoY) (NOV)	2.4%	2.6%	Medium
10:00	EUR	Euro Zone PPI (MoM) (NOV)	-0.2%	0.1%	Medium

 Critical Levels

CCY	SUPPORT	RESISTANCE
EURUSD	1.2960	1.3106
GBPUSD	1.5964	1.6115