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The near-term trajectory of the Japanese Yen against the US Dollar is veiled in uncertainty after mixed cues from December’s US jobs report jumbled relative yield expectations between Japan and America.

Japan’s savings rate is high relative to other developed countries, reflecting the expense of living on an island with limited space and scarce home-grown resources. This translates into Japanese investors’ preference for safe, liquid assets that offer stable income over a long period of time. Typically, this means a choice between either US or domestic government debt, with the favored asset determined by the yield difference between US and Japanese bonds. These underlying capital flows are the dominant driver behind USDJPY, with the pair now nearly 84% correlated with the spread between the yields on the two countries’ 10-year Treasury notes.

The outlook for US interest rates took a hit after December’s labor market figures fell short of expectations, showing the world’s largest economy shed 85,000 jobs versus forecasts of a flat result. However, the outcome was not without a silver lining as November’s numbers were revised higher to reflect a 4,000 jobs gain versus the originally reported 11,000 loss, which amounts to the first positive outcome in two years. Still, the market’s first reaction was that of disappointment as the 10-year yield spread moved by nearly a full basis point in favor of Japanese notes while a Credit Suisse gauge tracking the market’s priced-in US interest rate outlook for the next 12 months dropped to a four-week low.

Meanwhile, short-term interest rates seem to be telling a different story. Much of the Dollar’s weakness through 2009 was attributed to the fact that the cost short-term (3-month) borrowing in Japanese Yen surpassed that of the greenback for the first time since 1995, leading to the widespread proliferation of the short-USD carry trade. As of Friday, this yield advantage has narrowed to the smallest since August, suggesting the Yen is well on its way to reclaiming the dubious honor of the most favored funding currency.

On balance, it is unclear which one of these relationships will prove dominant in the near term. If the initial reaction seen in the 10-year bond spread sees follow-through in the week ahead, USDJPY is set to decline. Alternatively, if short-term rates take center stage that should encourage a repositioning of carry trade portfolios away from a short-USD to a short-JPY bias, leading USDJPY higher.