BORIS SCHLOSSBERG<br /><strong>DIRECTOR OF CURRENCY RESEARCH, GFT</strong><br /><br />NO country in the G20 has suffered more from the global recession than Japan. Although relatively low compared to the rest of the industrialised world, the country&rsquo;s unemployment rate remains at 5.4 per cent, the highest rate of joblessness in more than five years and the second worst in two decades.<br /><br />However, the true measure of Japan&rsquo;s economic pain can be found in the country&rsquo;s GDP statistics, which contracted in the first quarter of 2009 by a whopping 14.2 per cent. The export-driven Japanese economy was hurt by slumping global demand and rising yen values, which decimated profit margins for the country&rsquo;s key manufacturing sector.<br /><br />But despite the fact that growth was extraordinarily negative, Japan&rsquo;s currency continued to strengthen as investors unwound their carry trade positions through selling the high-yield currencies such as the Australian dollar while simultaneously buying back their yen shorts.<br /><br />This toxic dynamic appears to be reversing in the third quarter as risk appetite rises and the carry trade comes back into vogue. Thus, the Japanese economy is not only benefiting from the pickup in global demand, but also from the stabilisation of dollar-yen around the 95 level. With most Japanese businesses hedged around that point, currency valuations are finally proving supportive rather than disruptive. Little wonder then that Japan&rsquo;s latest current account surplus widened to &yen;1.8 trillion from the &yen;1.4 trillion forecast, while sentiment hit a two-year high.<br /><br />But the Japanese economy remains very fragile and vulnerable to both trade and capital flows in the third quarter. If the equity market rally begins to unravel, then the return of risk aversion will trigger a fresh wave of selling in the carry trade and will push yen higher.<br /><br />Dollar-yen at 90 remains the key line for Japanese policymakers. Should the pair come anywhere close to that level, the threat of intervention is likely to ensue. In the meantime, 95 now serves as critical support and as long as the pair remains above that level, the Japanese economy should continue to recover.<br /><br />Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read their daily commentary on currencies at or e-mail