The financial markets are becoming increasingly nervous about a significant surge in volatility surrounding the Japanese yen. This anxiety stems from the currency's sharp decline, reaching its lowest point since 1986, which raises concerns about possible intervention by Japanese authorities. Historically, Japan has intervened in the foreign exchange markets to stabilize the yen when it experiences significant fluctuations. Such interventions are aimed at preventing adverse effects on the Japanese economy, which relies heavily on exports.
A weaker yen can make Japanese goods cheaper and more competitive abroad, but it can also lead to inflationary pressures by increasing the cost of imports, particularly energy. The current situation, with the yen at its lowest level in decades, is causing widespread concern among investors and market participants who fear sudden, large-scale moves by the Japanese government to support the currency.
Investor sentiment is reflected in the widening volatility spreads, indicating that market participants are demanding higher premiums to protect themselves against sudden currency movements. These volatility spreads are essentially the difference between the implied volatility of options on the yen and the actual historical volatility. When these spreads widen, it suggests that investors are increasingly nervous about potential sharp moves in the currency and are willing to pay more to hedge against these risks. The accumulation of bearish bets on the yen signifies a growing consensus among traders that the yen will continue to depreciate.
This bearish sentiment is further underscored by a key measure of active trader positioning, which has turned more negative than at any time since 2022. This metric, which tracks the net positions of traders in the futures market, shows that more traders are betting on the yen to decline rather than rise, highlighting the pervasive pessimism about the yen’s prospects.
Despite warnings from Japanese authorities, it seems unlikely that these will prevent the yen from weakening further. This scenario heightens the possibility that officials may need to follow through on their threats to intervene in the market. Carol Kong, a currency strategist at the Commonwealth Bank of Australia, emphasized this point in her recent research note.
She noted that while verbal interventions and warnings from officials can sometimes have a short-term impact on the market, they are often not enough to change the underlying trends driven by economic fundamentals and market sentiment. The persistent weakness in the yen suggests that the market believes the factors driving the yen lower, such as Japan’s monetary policy divergence with other major economies and its trade balance, are likely to continue.
Masato Kanda, Japan's chief currency official, has stated that the country is prepared to step in and intervene in the currency market at any time, around the clock if necessary. This declaration underscores the seriousness with which Japanese authorities are monitoring the situation. Currency intervention by the Japanese government typically involves the Bank of Japan selling foreign currencies (usually US dollars) and buying yen in the open market to support the yen’s value.
Such interventions can be costly and complex, requiring careful coordination with other major central banks to ensure their effectiveness. Kanda’s statement is intended to signal to the market that Japan is ready and willing to act decisively to prevent further depreciation of the yen, but the impact of such statements depends on whether the market believes the authorities will follow through.
Although implied volatility in the yen appears to be relatively calm, the difference in its volatility compared to other currencies remains above the average observed since early 2021. Implied volatility is a measure derived from the prices of options on the yen, reflecting the market’s expectations of future volatility.
While the current level of implied volatility might seem subdued, the fact that it remains elevated compared to other major currencies indicates persistent concerns about potential sharp moves in the yen. This discrepancy suggests that, while day-to-day fluctuations might be manageable, there is an underlying fear of sudden, large-scale shifts that could disrupt the market.
As of June 18, hedge funds and asset managers held bearish positions on the yen worth approximately $14 billion, according to the latest data from the Commodity Futures Trading Commission. This amount is greater than the bearish positions on other major currencies and contrasts with the euro's net long positions, which are valued at $32.7 billion. The significant bearish bets on the yen reflect a widespread expectation among institutional investors that the yen will continue to decline.
These positions are often established through futures contracts, which allow traders to speculate on the direction of the yen withoutactually owning the currency. The contrast with the euro, which has net long positions, indicates that investors are more optimistic about the euro’s prospects compared to the yen, further highlighting the pessimism surrounding the Japanese currency.
A Citigroup Inc. gauge of active trader positioning in the yen has reached its most negative level since 2022 due to an increase in short positions on the currency. This indicates that traders are firmly bearish on the yen, but it also suggests that many of these positions might need to be quickly reversed if the yen suddenly strengthens. Short positions involve selling the yen with the expectation of buying it back at a lower price, profiting from the decline in its value.
However, if the yen were to unexpectedly strengthen, traders would need to buy back the yen quickly to cover their positions, potentially leading to a sharp, short-term rally in the currency. This dynamic creates a situation where the market could experience significant volatility if there is a sudden shift in sentiment or unexpected intervention by Japanese authorities.
The impact of the ¥9.8 trillion ($62 billion) that Japan spent on foreign exchange intervention earlier this year has already diminished. According to Hideki Shibata, a senior strategist at Tokai Tokyo Intelligence Lab, individual investors are waiting for another chance to sell the yen if the currency rises following another intervention. This observation highlights the challenges faced by Japanese authorities in managing the currency’s value.
While the previous intervention provided temporary relief, its effects were short-lived, and the yen has since continued to weaken. Individual investors, who play a significant role in the currency markets, are prepared to take advantage of any short-term strength in the yen to sell it again, anticipating further declines. This behavior underscores the deep-seated bearish sentiment and the challenges in achieving sustained stability in the yen’s value through intervention alone.
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27.06.2024
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