Trade of the Week | August 13-17, 2012

Two conditions historically conducive to weakness in Japan's currency have been building since the start of this month. During the week of 13-17 August, the yen responded.

When government bond yields in developed economies start rising, Japanese investors tend to shift more money overseas. In our New York FX Training Room earlier in the week, I mentioned the recent rise of benchmark yields in the bond markets which had previously benefited from strong inflows on the back of concerns about Europe. The benchmark 10-year US Treasury yield, for example, rose a significant 36 basis points from its 24 July close to 14 August close.

The odds of a weakening yen rise when widening bond spreads are accompanied by low currency market volatility. The implied volatility of three-month options on Group of Seven currencies sat at 8.50 percent on Tuesday, near its lowest since November 2007, according to an index compiled by JPMorgan Chase.

During the first hour of Wednesday's New York morning trading session, results of the New York Fed's August Empire State Manufacturing Survey were released. The current general business conditions index from that report, at -5.9, was the lowest reading in 10 months, also the first negative headline figure in 10 months.

Poor US economic readings tend to give the Japanese currency a boost. Yen strength following the weak Empire manufacturing report dragged the GBP/JPY currency pair to its daily central pivot point, situated a handful of pips below the 123.40 level which had previously influenced price action.

The yen's rally against the British pound fizzled starting about 30 minutes after the US news. The pair eventually attained a new six-week high before ending the European trading week less than 25 pips shy of the 125 handle. Traders who chose to hold the long position sat on a roughly 140-pip profit once the market closed for the weekend.