Hedge funds rebuild yen shorts as intervention creates fresh opportunities

Japanese authorities appear to be attempting to bolster the value of the yen, but this move has inadvertently provided currency traders with opportunities to regain short positions in the currency, according to a Bloomberg report. The yen has largely regained the gains made following the most recent coordinated US-Japan intervention, settling near JPY160 per dollar, just two weeks after the operation.

Investors still view the yen favorably due to Japan's interest rates remaining notably low compared to those in other developed nations. The yen's attractiveness as a funding currency for carry trades persists, a strategy that involves borrowing yen at low interest rates and investing in assets yielding more. When the Japanese currency experiences temporary strengthening due to official intervention, traders can capitalize on this by re-establishing short positions.

Hedge funds had significantly reduced their bearish yen exposure following the intervention, cutting their short bets by almost half by August 4th. However, some investors, including those from JPMorgan Private Bank and State Street Bank & Trust, are already resuming yen-funded carry strategies. Alpha Binwani Capital's founder, Ashwin Binwani, has begun buying dollars against the yen at around JPY157, essentially betting on further depreciation of the Japanese currency.

This trade remains appealing due to Japan's low policy rate of just 1%, which creates a significant yield differential with other major economies. Fiscal concerns are also contributing to pressure on the yen. Compared to other higher-yielding currencies, such as the Colombian peso, Turkish lira, and Norwegian krone, yen-funded short positions have yielded more than 10% this year.

State Street's Tokyo branch manager, Bart Wakabayashi, indicates that real-money investors are continuing to hold carry positions against a variety of Group-of-10 currencies, with the Australian dollar being the most popular counterpart, followed by the euro, US dollar, Canadian dollar, and pound. JPMorgan Private Bank's Asia head of rates and foreign-exchange strategy, Yuxuan Tang, suggests that the yen could potentially reach JPY162 per dollar if the dollar and US Treasury yields do not weaken substantially.

This scenario could place traders in direct conflict with Japanese policymakers. Japan is believed to have spent approximately $34 billion supporting the yen on July 31st, following an estimated $53 billion operation the previous day. If confirmed, this would represent Japan's largest single-day currency intervention ever. US Treasury Secretary Scott Bessent has expressed support for efforts to stabilize the yen, warning that further depreciation of the Japanese currency could contribute to a broader depreciation in Asian markets.

The intervention is also impacting Japanese investors. Ministry of Finance figures revealed that Japanese investors made the largest purchase of foreign assets in over two years last week, taking advantage of the strengthened yen following the authorities' intervention. However, the prospect of further official action makes the carry trade more susceptible to risks.

Another intervention or a faster-than-anticipated tightening cycle from the Bank of Japan could lead to a rapid unwinding of short-yen positions, potentially intensifying volatility across various markets. The Japanese government is reportedly in favor of advancing the next Bank of Japan rate increase, potentially as early as September or October.

Currently, markets are pricing in one quarter-point hike by October, although even this modest increase would leave Japanese borrowing costs well below those in the US.