The bout of uncertainty that has encircled the globe has already caused casualties in financial markets as risk aversion and heightened volatility send investors scrambling for haven assets. One of the first areas this phenomenon was evident was in the USDJPY pair which responded forcefully, briefly falling below the 100.00 psychological threshold as the carry-trade was rapidly unwound. However, the carry-trade was not the only factor behind USDJPY hurtling lower. Abenomics has largely been unable to raise the bar when it comes to reaching the ambitious inflation targets set by the Central Bank. Now that Abe has cemented his support in the government with the Liberal Democratic Party securing the upper house of the Japanese Diet (parliament), pushing through additional stimulus measures should be a breeze, helping to offset some of the recent strength in the Yen and send USDJPY higher over the coming weeks.

LDP Tightens Its Grip

The sweeping election victory in Japan has led to a global risk rally that has included Asian, European, and American equities, sending the S&P 500 into record territory with a new high close. However, long before the victory, all was not well with the Japanese economy. Slipping fundamentals have raised the stakes for Shinzo Abe, especially after the high profile failure of his first three arrows.Inflation has been a troublesome indicator for the Central Bank, with annualized consumer prices printing in negative territory during 3 of the last 4 readings, with the latest showing deflation of -0.40% and only deepening as time passes.Although Japanese firms have reported record profitability over the past several years due to the weakening of the Yen, those gains have not translated to upside in wages, a factor that is keeping the downward pressure on inflation persistent.

One of the main problems going forward for the Bank of Japan is its already sizable balance sheet which is only growing over time, hurting the markets pricing function in bonds especially as the Central Bank soaks up available liquidity. The amount of purchases also makes it difficult for the BoJ to expand the existing program further, meaning that the next stimulus move will have to take a different approach. With former Federal Reserve Chair Ben Bernanke meeting with Shinzo Abe earlier, the takeaways from the meeting include a focus on fiscal stimulus, or heightened government spending in order to combat deflation and negative price growth.Fiscal spending will also likely help alleviate pressure in other areas especially after the latest machinery orders data which showed a year over year contraction of -11.70%.

However, despite the renewed sense of urgency when it comes to implementing fiscal stimulus, this may not be enough to weaken the Yen over a prolonged period of time.For one, rising volatility in financial markets may precede a major turning point, a factor that could see the Yen carry-trade unwind, a move that would crush Japanese exporters. While some market participants are cheering the new highs in stock benchmarks, 2016 is staring to feel eerily similar to 2007 when US benchmarks also made new highs before the onset of the great recession. Due to the wide interest rate differential between the US and Japan which currently stands at 0.60%, more risk aversion on a global scale could send the USDJPY pair back below the 100.00 threshold in spite of expanded stimulus.Moreover, it could severely dampen Abe’s plans to restore inflation to the economy.

Technically Speaking

Despite the Abe stimulus bounce, technical indicators for the USDJPY remain overwhelmingly negative at present.For one, both the 50 and 200-day moving averages are trending lower above the price action, acting as resistance against any prolonged upward movement in the underlying pair. Additionally, the formation of an equidistant channel formation adds to the ongoing bearish bias in USDJPY. The channel which has been guiding the pair lower, which began to emerge back in May continues to trend lower, with trend following strategies ideal for trading the channel. Bearish positions established near the upper trend line should be set to target the lower channel line.However, a candlestick close above the upper channel line could be the beginning of a channel-based breakout to the upside, signifying a reversal in the pair.However, absent a reversal near-term, it could suggest the longer-term USDJPY downtrend will remain intact.

Looking Ahead

Although there are no major economic announcements due this week out from Japan, the US is set to release retail numbers and inflation data later in the week. If inflation continues to rise in the US, it could foreshadow higher interest rates, helping to offset recent Yen strength. For the Yen, the main driver that will move the needle is a stimulus announcement which will help weaken the Japanese currency. Yen weakness will bolster the drive for higher inflation and also added economic competitiveness, two items currently in short supply for Japanese policymakers. However, in the event of further global risk aversion or absent a new, aggressive approach to stimulus, Japan is likely to see the economy sag, sending USDJPY back below 100.00.