USD/JPY historical cycles

The bearish case for USD/JPY can also be illustrated in the long-term behavior of the pair. It shows cyclical lows in USD/JPY have occurred in 1995, 2000, and 2005, with each case coinciding with the early stages of Fed tightening cycles.

Considering the five-year intervals of these lows and the shrinking fabric of the capital structure of U.S. banks, a cyclical bottom in USD/JPY may not materialize until later in 2009 or in 2010. Bad credit continues to erode the link between employment and spending, and rising joblessness further affects consumer spending, which in turn will dampen corporate earnings and prolong the drag on business loans and credit.

In such a gloomy earnings environment, prospects for a long-lived recovery in equities become equally downcast. This means a large portion of global capital will remain parked in the less-risky currencies of Japan and Switzerland because of their low yields. The dollar could drop below the 14-year low of 87.11 yen reached in December, and ultimately fall as low as 75.

The looming threat of U.S. automaker bankruptcy and its potential repercussions on the economy as a whole particularly support this scenario. The U.S. auto industry’s overall contribution to GDP is about 4 percent, with $12 billion spent annually on research and development. The Big Three also employ more than 240,000 direct workers and five million indirect workers, and provide healthcare for two million employees. Despite having secured a $13.4 billion bridge loan from the government, U.S. automakers remain on life support until the end of this quarter, when Congress will assess the need for additional financing.

The bullish case for risk appetite and the economy may be underlined by the 50- to 60-percent decline in fuel prices, the approximate 70-percent drop in crude oil from its July high, and record-low long-term mortgage rates. However, these positive developments do not offset the threat of renewed economic deterioration, especially since the effects of the credit crunch through the various consumption channels has yet to run its full course. With the U.S. unemployment rate at a 16-year high of 7.2 percent as of early January, retail sales showing its biggest losing streak in more than 25 years, and consumer confidence at record lows, none of these indicators have shown signs of a bottom.