Election uncertainty
JPY rallied 3.9% last week and traded at a five month high versus the USD in Monday's trade. The main driver for FX trade is the direction of equity markets and risk appetite. Demand for JPY is generated by fear that the global recovery may be delayed and by uncertainty about the upcoming US earnings report. Over the weekend, Japan's ruling LDP party suffered a heavy loss in municipal elections. Despite the LDP loss, Japan's Prime Minister and leader of the LDP party, Aso, called for national election to be held on August 30th. The LDP party has been in control of national power in Japan for over 50 years. This weekends municipal election results may be the beginning of the end for the LDP party rule. The August 30th national election presents the best chance in the last half-century that the LDP will lose majority control of the Japanese diet to the opposition DPJ party. The DPJ party has pledged to diversify Japan's reserves if elected. A shift in political power structure in Japan could have significant impact on the USD if Japan elects to reduce its holdings in the USD. USD reserves status will be a major election issue. Investors will also be monitoring the DPJ's fiscal policy platform to see if Japan's opposition party will seek to issue more JGB's if the DJP gains control of the upper and lower houses of Japan's parliament. Japan's election uncertainty may reduce JPY safe haven attraction. JPY gains may be limited by election uncertainty.

Strong JPY/weak economy increases the risk of intervention
Japan's economy remains weak but there are signs that the recession may be easing. Monday Japan reported improvement in industrial production and a rise in consumer sentiment. The Japanese government upgraded Japan's economic assessment for the third month in a row Monday. The Japanese government however warned that the Japanese economy remains in a severe condition. The current JPY rally presents additional risks for Japan's economy and inflation outlook. The strengthening of the JPY may reduce demand for Japan's exports. Rising JPY makes Japan's goods less competitive. The strengthening of the JPY may also increase additional risk of deflation in Japan. Japan's consumer prices fell at a record pace in May. Falling prices reduce the chance of economic rebound. Japanese officials have turned up the volume on verbal intervention to try and slow the JPY rally. Japan's Cabinet Secretary Kawamura said that excessive FX moves are undesirable and that the Japanese government is watching FX markets closely. Japan's economics Minister Hayashi said that further stock losses and JPY gains could hurt Japan's exports and manufactures. These comments increase the risk of intervention and have generated debate over what level Japanese officials may implement physical intervention. Consensus is that physical intervention will likely emerge if USD/JPY trades below 90.00. The odds of physical intervention increase if USD/JPY approaches the 87.00 level. JPY gains may be limited by threat of intervention.

Direction of equities /US corporate earnings
Global equity markets rallied sharply from March until the end of June with gains of close to 40%. Equity markets have weakened over the last four weeks pressured by concern that the global recession may drag on and economic recovery may be delayed. The rally in JPY has been inversely correlated to the recent selloff in equity markets. If equity markets continue to decline expect more unwind of JPY carry trades and increased demand for the JPY. Monday, US equity markets surged led by gains in financial and consumer stocks. The rally carried over into Asian and European equity market trade with the markets supported by comments from US Treasury Secretary Geithner that the global recession is easing and in reaction to better than expected earnings Goldman Sachs and Johnson & Johnson. JPY ended the session lower in Monday's trade and traded mixed Tuesday as rising equity markets limit safe haven demand for the JPY. Focus turns to this week's US earnings reports with J.P. Morgan Chase earnings due for release Thursday and Bank of America and Citigroup scheduled to report earnings Friday. 31 of the S&P companies are due to release earnings this week. How the US global and equity markets respond to this week's US earnings reports will be key to the direction of JPY. Analysts at Barclays look for USD/JPY to trade to 87.00 in the months ahead because they expect continued weakening of equities and commodities prices. An upside surprise in US earnings reports could fuel fresh equity and commodity market gains, presenting a challenge to Barclay's JPY forecast. US Treasury Secretary Geithner says that there's a good chance the United States and other leading economies will resume growth later this year and not face a double dip recession. JPY may be ripe for a downside correction if US earnings surprise to the upside and hope for a global recovery re-emerges.

Key technical levels to watch in USD/JPY include support at 89.70 the February 11th low and 88.85 the February 4th low with resistance 94.35 the 10 day moving average.