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  •  It's firmly risk-off at the start of the European session and the dollar has gained strong upward momentum across the board.
  •  Dollar yen breaks out of range but US yield correlation continues to break down

USDJPY has confounded market expectations and remained range bound even while US-Japanese yields broke higher. This was a surprise, since the two usually track each other very closely.

Yesterday, USDJPY broke above the 83.20/30 level - the recent highs - just as the spread started to narrow, as you can see in the chart below.

USDJPY and US- Japanese 2-yerar government bond yields.


What does this tell us:

1, that the relationship between US yields and USDJPY has broken down for now. Since the start of the year the correlation between USDJPY and 2-yr US yields has been an insignificant at 0.44. This compares with a correlation of 0.65 over the past 6 years.

2, It also tells us that the yen is not currently trading like a safe haven. Although fears about the outcome from Egypt's political turmoil and worries about the impact of rising inflation on the global growth are causing a drift away from risk assets, the yen - a traditional safe haven currency - hasn't been able to muster much of a rally and the trade weighted yen has fallen nearly 3 per cent since the start of this year.

There are two reasons keeping a lid on yen gains in our opinion:

- Japan's sovereign credit rating was cut by S&P last month and Japan's massive public debt burden is starting to erode the attractiveness of the yen.

- We will get confirmation of the weakness of Japan's growth picture next week. Fourth quarter GDP is released late on Sunday night (2350 GMT/ 1850 ET) and it is expected to show that the economy contracted by 0.5 per cent. Economic indicators since the beginning of the year haven't been too impressive either: wages were lower, bank lending fell last month and the current conditions component of the Economic Watchers Survey was also lower, which tracks the yen quite closely as you can see in the chart below.

Overall, the yen is looking weak in our opinion and could fall further. Some levels on the upside to look out for in USDJPY include: 84.20 - 200-day moving average and possibly all the way back to 87.00 - the 61.8% retracement extension of the move higher from the October 2010 low to December 2010 high.

Trade-weighted yen (white line) and the current conditions component of the Economic Watchers Survey, monthly chart.


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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