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Yen Weakness Far From Over

NEW YORK ( TheStreet) -- In early April, I made the case for prolonged weakness for assets denominated in Japanese yen. This forecast proved largely accurate, as the CurrencyShares Japanese Yen Trust ETF (FXY) is 14% lower on the year; and the yen itself is the second-worst performing developed-market currency relative to the U.S. dollar.

To some, these declines might suggest renewed opportunities to buy. But when we consider the policy outlook at the Bank of Japan, and potential cutbacks in monetary stimulus from the Federal Reserve, there is little reason to believe this downtrend has reached a true bottom.

To the contrary, the yen remains a sell, even at these weaker levels. Major divergences in central bank policy favor the U.S. dollar over its Japanese counterpart, and these are trends that should continue well into 2014. In Japan, the intention has been to ramp up bond-purchasing programs as a means to normalize consumer inflation levels.

The Bank of Japan's central aim is to achieve inflation rates of 2% in the next two years and reverse decades of stagnant growth. Stimulus plans in Japan make up a larger percentage of GDP than the quantitative easing programs designed by the Fed, and this can only weaken the yen as long as policymakers remain committed to this course of action.

Diverging Policy Favors Dollar

Diverging policy in the U.S. and Japan has created bond-yield differentials in 10-year government debt that is now at multi-year highs above 2.2%. Confirmation that the Fed is truly ready to reduce monthly asset purchases and allow the U.S. economy to start working on its own merits will only propel these trends, and this could start as early as next week. Currently, markets are expecting the Fed to reduce monthly stimulus injections by $10 billion, so any number greater than that will push the U.S. dollar to new highs for the year.

Looking ahead, the fate of the yen rests on Prime Minister Abe's level of commitment in achieving official inflation goals and weakening the currency to support export companies. Early indicators will be seen in decisions to raise the national sales tax to 8% and measures to cut levies in corporate income. Some of these decisions could be finalized as early as next month.
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