DJ Forex Focus: The Yen Looks Set To Resume Its Slide

The yen looks set to resume its slide against the dollar after a brief respite last month.

The Greek rescue package last weekend lifted the market only slightly amid ongoing concerns over a spillover effect, even though evidence elsewhere indicates a global economy in recovery.

So instead of benefiting as a safe haven, the yen is once again exposed as a funding currency as investors move back into higher-yielding, more risky assets. The dollar was able to climb to a new eight-month high of Y94.99 Tuesday.

See the dollar's recent rise against the yen:

Recent events in Greece are also proving negative for the yen in another way, by focusing market attention on Japan's debt problems and the risk they still pose to the country's AA credit rating.

If next month's budget program from the government disappoints, Japan could also face a downgrade by credit agencies, as Standard & Poor's Corp. reminded financial markets this weekend.

The economic problems still facing Japan were brought into stark relief this week as the U.S. reported another month of strong manufacturing activity and Australia hiked interest rates once again.

The higher-than-expected increase in U.S. manufacturing has raised hopes that this Friday's non-farm payrolls will also show a surprise improvement, making it more likely that U.S. interest rates may rise sooner than previously expected.

Japan is still struggling with the specter of deflation. Late last week, the members of the Bank of Japan's policy board suggested that the end of deflation may be in sight but the central bank itself still hasn't raised its forecasts.

However, the country's fiscal position, with national debt twice the size of annual GDP, is posing the bigger risk for now.

Financial market participants expect the Japanese government to take measures to cut its deficit next month, despite upper-house elections scheduled for July.

Last week, Japanese Finance Minister Naoto Kan warned that the Greek experience means that Japan will have to take "very firm" action.

Even if the government does come up with appropriate cuts and preserves the country's credit rating, Japanese interest rates are still likely to remain at current low levels for some time to come even as most other major economies start to contemplate tighter policy.

Hopes that China might provide a lift for Japan by revaluing its currency were dented by last weekend's announcement from Beijing that reserve requirements are being increased for the fourth time this year.

The measure, aimed at cooling the Chinese property boom, probably means that more aggressive policy moves by the Peoples' Bank of China, such as revaluing the yuan, have been put on hold for now.

All this should make sure that the yen remains on the slide even though a high level of net shorts in last week's data from the Chicago Mercantile Exchange suggest the risk of a short squeeze.

Nevertheless, a dollar break over Y95.00 should soon take the U.S. currency up to its next resistance level at Y95.75 and Y97.10.

Early Wednesday, the dollar was up at Y94.92 by 0645 GMT from Y94.40 late Tuesday in New York, according to EBS.

The euro was down at $1.2978 from $1.3001 as concerns about other euro-zone debtors remained a major issue even though Spanish Prime Minister Jose Louis Zapatero dismissed suggestions that Spain is negotiating a bailout. Investors are waiting to see if the euro slips to its next support level at $1.2885.

The level of the yen's wider weakness was also evident in the euro's rise to Y122.21 from Y122.71.

The pound rose to $1.5159 from $1.5091 despite concerns that the U.K. general election Thursday may result in a hung parliament.

Bloomberg TNI FRX POV

   Reuters   USD/DJ    Thomson   P/1066 or P/1074 

(Nick Hastings has covered the foreign exchange markets and industry for over 20 years. Apart from his written commentary and analysis, he also appears on Fox Business News and CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 or by email: nick.hastings@dowjones.com)