Analysis-Yen’s changing fortunes might finally be spooking the bears

Just six weeks after plummeting to its lowest level in four decades against the dollar, the Japanese yen appears to be on the mend as a combination of factors gradually dissuades bearish traders. Central bank rate hikes and record currency interventions have failed to provide sustained support for the currency, but new influences such as capital repatriation, unwinding carry trades, and U.S. political pressure have made short speculators reconsider their long-term strategies.

Fixed income manager Rong Ren Goh of Eastspring Investments notes that investors are now less likely to aggressively short the yen, especially with the possibility of a Bank of Japan rate increase in September adding more risk to the trade. Although a 50-basis-point hike by the BOJ remains highly unlikely, particularly under Governor Kazuo Ueda's cautious approach, the market mood is shifting.

Citigroup data shows that yen positioning has flipped from bearish to bullish since early August, with leveraged funds, banks, and real-money investors net buying yen. This change in market sentiment, along with central bank policy, investment flows, and speculative positioning, has increased volatility. The yen is projected to surge 2.3% against the greenback this week, its most significant gain since a rare U.S.-Japan intervention in July.

Analysts warn that the rapid unwinding of yen-based carry trades, similar to the 1998 collapse of Long-Term Capital Management, could occur frequently before a major move. The yen's prolonged weakening trend intensified this year due to fiscal concerns surrounding Japanese Prime Minister Sanae Takaichi's stimulus plans and the BOJ's perceived delay in tightening monetary policy.

In July-August, Tokyo's record solo intervention in response to the yen's weakness caught global attention. U.S. Treasury Secretary Scott Bessent's advocacy for rate hikes during the Group of 20 finance chiefs meeting, along with BOJ board member Hajime Takata's warning of potential 50-basis-point hikes or quicker increases, has added to the speculation.

With a 97% chance of a 25-basis-point rate hike and a 27% chance of another increase in October, BOJ policy seems to be a major driving force behind the yen's recovery. Meanwhile, domestic institutional investors are repatriating funds due to rising Japanese government bond yields, further supporting the yen's upward momentum.