Yen recovery spreads across global markets

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The yen’s strong rally has sent shockwaves through global markets and put the currency on track for its best month this year, setting the stage for further volatility around meetings of the Japanese and US central banks this week.

The yen has risen 4.7 percent against the dollar in July, buoyed by expectations that the Bank of Japan could raise interest rates on Wednesday, narrowing a wide gap with the Federal Reserve’s borrowing costs that has pushed the currency to multi-decade lows. Expectations of a Fed rate cut have also increased after U.S. inflation fell earlier this month.

The currency’s rally was fueled by the unwinding of popular “carry trades,” in which investors borrow in yen to finance purchases of higher-yielding currencies, and pushed bets against the yen to their highest in about two decades.

As investors rushed to cut losses from failed carry trades, they were forced to sell assets in other markets, adding to a sharp sell-off in global technology stocks, analysts said.

“Forex is impacting everything right now, as yen-funded carry trades have been one of the most popular trades this year — the trimming of positions is also affecting other risk positions,” said Athanasios Vamvakidis, global head of foreign exchange at Bank of America.

While the yen was steady on Friday, forex traders said volatility will intensify next week as markets brace for a decisive Bank of Japan interest rate decision and adjust to a global shift in risk appetite and a large unwinding of speculative currency positions.

These predictions were made by traders at three investment banks in Tokyo over the weekend as the yen jumped from 157.5 yen to the dollar to 153.71 yen.

But traders also warned that the BoJ’s decision on Wednesday to keep interest rates unchanged could trigger a swift reversal for the yen, sending it back to the low of 161 yen per dollar where Japanese authorities are suspected of intervening in mid-July.

“The real action could get interesting next week for the yen, because the backdrop ahead of the BOJ meeting is very different as the market sentiment towards the carry trade has clearly changed,” said Benjamin Shatil, foreign exchange strategist at JPMorgan in Tokyo.

“There are still a lot of yen shorts out there that could be unwinded if we break above 152. At the same time, if the BOJ doesn’t make any major announcements, there may not be much resistance to the yen falling again,” he added.

Traders in the swaps market are evenly divided on the prospect that the Bank of Japan will raise its key interest rate by 15 basis points to 0.25 percent next week, up from a quarter-point chance earlier this month.

Most prominent was the influence from US politics, including Donald Trump’s comments that the US was having a “major currency problem” due to a weak yen and yuan, signaling that he would likely consider various options to weaken the dollar if he wins the presidential election in November.

This comes amid a sharp sell-off on Wall Street led by tech stocks.

“The most crowded fund manager trades have been long tech stocks and short yen in FX… this week has seen the most crowded trades take place and I’m sure there has been some crossover between the two,” said Chris Turner, global head of research at ING.

BoJ watchers believe the monetary move puts the central bank in a difficult position, as the current economic situation appears to justify a small rate hike. Analysts say if the BoJ decides not to act, markets may decide it has been restrained because the yen is now stronger, allowing markets to interpret the decision as purely reactive.

“People have made a lot of money shorting the yen over the past two years… which will tend to come back if the BoJ doesn’t raise rates,” Turner said.

Additional reporting by Kate Duguid in New York