By Jamie McGeever
ORLANDO, Fla. (Reuters) – Speculative carry trades funded in Japanese yen have completely declined, according to one measure.
The latest data from the Commodity Futures Trading Commission shows that hedge funds and speculators have reversed their short positions in the yen and are now net long in the currency for the first time since March 2021.
It may have taken a lot in recent weeks to trigger this shift — hawkish Japanese interest rate hikes, yen-buying intervention, and increased safe-haven demand amid a historic spike in U.S. stock market volatility earlier this month — but the shift has been swift.
Data for the week ending August 13 shows that funds held a net long position of just over 23,000 contracts, representing a bullish bet on the currency worth $2 billion.
Just seven weeks ago, their net shorts were 184,000 contracts. That was their largest short position in 17 years, with their bet against the currency totaling $14 billion. The magnitude and speed of the upside momentum shift in July and so far this month has been historic.
A short position is essentially a bet that the value of an asset will fall, and a long position is a bet that its price will rise.
As analysts at Rabobank point out, the yen was the best performing G10 currency against the dollar in July, rising more than 7%. But it has started to weaken again as the volatility shock of August 5 fades and investors regain their appetite for risk.
The question now is whether CFTC funds and speculators more broadly will be tempted to return to profitable yen-funded trades. There are compelling arguments on both sides.
But the barrier to extending long yen positions and further appreciating the yen may be higher. The US economy is still growing at a decent pace – at a 2% annual rate, according to the Atlanta Fed’s latest GDP model estimates – and the dollar’s interest-rate and yield advantage over the yen remains large.
Yen trading – selling yen to fund the purchase of higher-yielding currencies or assets – is an attractive strategy from a fundamental perspective despite recent turmoil.
“We continue to believe it is difficult for the dollar (or yen) to fall significantly or sustainably in the current environment,” Goldman Sachs foreign exchange analysts wrote on Friday.
On the other hand, the recent turmoil is not yet completely over, and volatility may remain above pre-August 5 levels for some time. This is bad news for carry trades, which rely on low and stable volatility.
The one-week to six-month implied volatility measures for USD/JPY are higher than expected, especially further down the curve. It may take a more significant drop in volatility before speculators consider shorting the yen again.
Figures on Friday are expected to show that inflation in Japan rose to 2.7% last month, the highest since February, which could prompt the Bank of Japan to continue tightening monetary policy. All this while the Federal Reserve prepares to start cutting interest rates.
“While the spread between (U.S. and Japanese) interest rates will remain attractive, the risk is that we have entered a period of more sustained volatility that will encourage further yen unwinding over the coming months,” Morgan Stanley’s foreign exchange strategy team wrote on Friday.
(The views expressed here are those of the author, a Reuters columnist.)
(Written by Jamie McGeever, Edited by Michael Perry)