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The yen’s dramatic rebound has shocked global markets, putting it on track to post its best month of the year and setting the stage for further volatility ahead of Japanese and U.S. central bank meetings this week.
The yen rose 4.7 percent against the dollar in July, boosted by the possibility that the Bank of Japan will raise interest rates on Wednesday, narrowing the gap with borrowing costs from the U.S. Federal Reserve that has pushed the yen to its lowest in decades. Expectations of a Fed rate cut are also rising after U.S. inflation fell earlier this month.
The yen’s recovery has been fuelled by the unwinding of a popular “carry trade” in which investors borrowed yen to fund purchases of higher-yielding currencies, driving bets against the yen to their most extreme levels in nearly two decades.
Analysts say investors’ rush to cut losses from carry trade gone wrong has forced them to sell assets in other parts of the market, fuelling a sharp selloff in global tech stocks.
“The currency market is moving everything right now because the yen-denominated carry trade has been one of the most popular trades this year, and the reduction in positions is having an impact on other risk positions as well,” said Athanasios Vamvakidis, global head of foreign exchange at Bank of America.
The yen steadied on Friday but foreign exchange traders see increased volatility next week as markets brace for the Bank of Japan’s extreme interest rate decision and adjust to shifts in global risk appetite and a massive unwinding of speculative currency positions.
The forecast, made by traders at three Tokyo investment banks, came at the end of a week when the yen surged from 157.5 to the dollar to 153.71.
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But traders also warned that a decision by the Bank of Japan to keep rates unchanged on Wednesday could send the yen reversing sharply toward a low of 161 yen to the dollar, where Japanese authorities are believed to have intervened in mid-July.
“There’s clearly been a shift in market sentiment towards the carry trade and it could be really interesting for the yen next week as the situation is very different heading into the Bank of Japan meeting,” said Benjamin Shatyr, currency strategist at JPMorgan in Tokyo.
“There are still a lot of short positions in the yen that could be unwound if the yen breaks through 152 yen. At the same time, if the BOJ refrains from making any substantive announcements, there may be little resistance to the yen falling,” he added.
Swaps market traders are split on the prospect that the Bank of Japan will raise its policy rate by 0.15 percentage point to 0.25 percent next week, up from a 25 percent probability earlier this month.
Overshadowing this are influences from the US political scene, including Donald Trump saying the US has a “big currency problem” due to the weakness of the yen and yuan, and suggesting he may consider other options to weaken the dollar if he wins the presidential election in November.
This happened alongside a major sell-off on Wall Street, led by tech stocks.
“The busiest trade among fund managers was buying tech stocks and in currencies they were selling the yen,” said Chris Turner, global head of research at ING. “The busiest trades have cleared this week and there has certainly been some overlap between the two.”
Bank of Japan watchers believe the currency fluctuations have put the bank in a tricky position, as the current economic situation seems to justify a small rate hike. If the BOJ decides not to raise rates, analysts say, the market may conclude that the yen has strengthened, causing the BOJ to refrain from raising rates, and interpret the BOJ’s decision as merely reactive.
“People have made a lot of money shorting the yen over the last two years and if the Bank of Japan doesn’t raise interest rates they will be inclined to short it again,” Turner said.
Additional reporting by Kate Duguid in New York
