(Bloomberg) -- Signs of an inflection point for the yen are mounting amid growing expectations that the interest rate gap between Japan and the US is finally set to shrink.
The currency rallied more than 1% on Thursday as it extended its sharp rebound over the last two weeks from lowest level against the dollar since the 1980s. The advance has been spurred on by Japan’s apparent intervention to support the yen, a slashing of bets against the currency by hedge funds and the unwinding of global carry trades that have been weighing it down.
Whether the advance that’s roiling markets now proves to be a turning point will likely come down to the decisions next week of the Bank of Japan and the Federal Reserve. Some 90% of BOJ watchers see the risk of it hiking rates on July 31, even if that is not their base-case outcome, and the Fed is facing growing calls to start cutting rates the same day.
“This certainly looks like positions coming off ahead of a possible rate hike in the face of some much better timed intervention,” said Kit Juckes, chief FX strategist at Societe Generale. “These are sizable moves and this pushes up volatility. And as volatility goes higher, the cost of holding the position gets bigger. So it has the capacity to unravel.”
The yen was up 0.7% at 152.75 versus the dollar at 3:34 p.m. in Tokyo, trimming some of the earlier surge while holding on to its fourth straight day of gains and outperforming all of its Group-of-10 currency peers. The yen’s strength dragged the Australian dollar down for a ninth day and helped pull China’s yuan to the highest in more than a month. The impact also spilled over into Japanese stocks, with the currency rally adding to declines that were triggered by a slump in US equities.
“The yen is buoyed by an unwind of carry trades given heightened risk aversion from a tech selloff, and still heavy speculative short positioning,” said Wei Liang Chang, macro strategist at DBS Bank Ltd. “Unease among yen bears is also deepening with Japanese monetary policy possibly tightening next week, in contrast to coming rate cuts by the Fed and ECB. Further yen strength into the BOJ meeting next week cannot be discounted.”
Swaps pricing Thursday pointed to a 58% chance of the BOJ hiking rates by 15 basis points by July 31, up from around 0.29% last week. Such a hike by Japan would still leave the rate gap to the US at about five percentage points, but investors see the prospect of bigger cuts from the Fed making an impact in narrowing the gulf before too long.
The recent volatility is unwanted by carry traders, who favor stability as well as Japan’s ultra-low interest rates when they borrow in yen to then invest in currencies with higher yields.
“Two weeks ago, literally everyone was talking about yen-carry trades, but now it looks people have totally forgot about it and are unwinding their positions,” said Yusuke Miyairi, FX strategist at Nomura Plc in London.
The yen has recently tended to surge as London trading kicks off, pointing to moves by global investors to unwind carry trades.
Meanwhile, leveraged funds slashed their net short yen positions in the week ending July 16 by the largest amount since March 2011, according to the most recent batch of data from the US Commodity Futures Trading Commission. Asset managers also cut their bets against the yen by the most in a year.
“We think the yen will become a bit more attractive, so we reduced our shorts,” said Andreas Koenig, the London-based head of global FX at Amundi SA, Europe’s largest asset manager. “We saw intervention in the yen recently, so the uncertainty of holding a short yen position is rising. We also have the argument that the US might start its easing cycle relatively soon, which could weaken the dollar,” he said in an interview last week.
Homin Lee, senior macro strategist at Lombard Odier Singapore Ltd., said the yen’s rally will create a degree of caution for the equity market in the near-term because the weak currency has been a key driver of its strong performance.
Tomo Kinoshita, global market strategist at Invesco Asset Management Japan, said the slump in the Nikkei Thursday was driven by the fall in US stock prices. But he added that the “increasing possibility of a rate hike at BOJ’s July meeting brought in sharp yen appreciation, which contributed to a fall in export-oriented stocks and stocks that heavily rely on borrowing.”
--With assistance from Winnie Hsu, George Lei and Rachel Evans.
(Updates prices and charts, adds impact on other currencies)
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