[FXJourney]

The outlook for the JPY is a gradual depreciation despite short-run volatility. Recent USD-JPY gains partly reflected exaggerated speculation of the new Democratic Party of Japan (DPJ) cabinet’s support for a strong JPY. As the DPJ’s
policy initiatives are failing to attract global equity investors, the JPY’s recent gains should not be sustainable. At the same time, USD-JPY has not been exempt from broad USD weakness recently. The JPY’s status as the most preferred carry trade funding currency has weakened, as cheap USD funding costs have fostered USD carry trades as well. The 3-month USD LIBOR has remained below the 3-month JPY LIBOR since late August. As a result, a sustainable USD-JPY rally probably requires a widening of US-Japan yield differentials. With the BoJ likely to be on hold for at least year, this is most likely to be triggered by markets reacting to the scaling back in liquidity provision by the Federal Reserve and eventually moving to price in a Fed tightening cycle. As such, a fully fledged USD-JPY rally now seems unlikely until late 2010.