Yen is Vulnerable

Japan's markets are closed until Thursday. That means that Japanese exporters believed to have capped the dollar's upticks in the JPY94.40-70 in recent weeks may not be there now. At the same time, a recovery in US equities and rising US yields may also favor a push higher for the greenback.

We note that the dollar-yen exchange rate is more correlated to interest rate differentials and is it has been fairly steady this year. Conducting the correlation at the level of percentage change, finds the correlation between US-Japan 2-year differentials and dollar-yen is about 69.2%. The correlation at with 10-year differentials is 71.1%. This correlation has been relatively steady over the past month, when US Treasuries appeared to draw a safe haven bid when Greece and peripheral European tensions were running high. Over the last month the correlations have been 79% and 71.8% for the 2-year and 10-year differentials respectively.

Over note, the correlation between the S&P 500 and dollar-yen is about 47% year-to-date but increased to almost 68% over the past month.

Although the euro does not seem to reflect it, the anxiety in the European debt market has eased and this has seen US Treasury yields rise and the S&P 500 is higher in the early going. These considerations underpin the dollar against the yen. The greenback has tested Friday's high, just below the April high near JPY94.80, which was the highest the dollar has reached since last August. The key psychological JPY95 area offers resistance and there is talk of option structures struck near there. Over the next few month, there may be potential toward JPY100, but this may require higher US interest rates.

The growth outlook for the Japanese economy appears to have improved, but the base is fairly narrow, capex and exports, though consumption has been stronger than the market expected. However, deflationary forces remain and the risk is that they intensify. The waiving of high school tuition is expected to push the CPI down another 0.5%, for example.

Bearishness toward to the yen is well documented. The non-commercials (speculators) at the IMM are as short the yen as they have been since Q3 07. To keep this in context note that non-commercials have a record short euro position, while the record short yen position is 4 times larger than the current one.