By Jamie McGeever
ORLANDO, Florida (Reuters) — The speculative carry trade financed by the Japanese yen has completely unraveled, according to one indicator.
The latest data from the Commodity Futures Trading Commission shows that hedge funds and speculators have unwinding their long-standing brief position in the yen and are now net-long in the currency for the first time since March 2021.
A lot had to happen in recent weeks to trigger this turnaround — an aggressive rate hike by Japan, intervention by buying the yen and a surge in demand for safe-haven assets amid a historic spike in U.S. stock market volatility earlier this month — but the turnaround came quickly.
Data for the week ending August 13 shows the funds held a net-long position of just over 23,000 contracts, effectively a $2 billion bullish investment in the currency.
Just seven weeks ago, they were net brief 184,000 contracts. That was their largest brief position in 17 years, a $14 billion bet against the currency. The size and speed of the bullish momentum shift in July and so far this month are historic.
A brief position is essentially a bet that the value of an asset will fall, and a long position is a bet that its price will rise.
Rabobank analysts point out that the yen was the best-performing G10 currency against the dollar in July, gaining more than 7%. However, it has started to lose value again as the volatility shock of August 5 has subsided and investors have regained their appetite for risk.
The question is whether CFTC funds and speculators more broadly are willing to return to yen-funded carry or not. There are compelling arguments on both sides.
The bar for expanding long yen positions and further appreciation of the yen may be higher. The U.S. economy is still growing at a decent pace — 2% annualized, according to the latest estimates from the Atlanta Fed GDPNow model — and the dollar’s advantage over the yen in terms of interest rates and yields remains significant.
The yen carry trade – selling yen to fund the purchase of higher-yielding currencies or assets – is an attractive strategy from a fundamental perspective, despite recent turmoil.
“We continue to believe it is difficult for the dollar to decline significantly or sustainably (or remain bullish on the yen) in the current environment,” currency analysts at Goldman Sachs wrote on Friday.
On the glowing side, the recent turmoil is not entirely in the rearview mirror yet, and volatility could remain above pre-August 5 levels for some time yet. This is bad for carry trades that rely on low and stable volatility.
Measures of implied dollar/yen volatility over a one-week to six-month horizon are higher, especially further back in the curve. A more significant decline in volatility may be needed before speculators again consider selling the yen brief.
And data on Friday is expected to show that inflation in Japan rose to 2.7% last month, its highest level since February, likely prompting the Bank of Japan to tighten policy further. All this as the Fed looks to start cutting interest rates.
“While the (US-Japanese) interest rate spread will remain attractive, there is a danger that we have entered a period of more sustained volatility that will encourage further unwinding of yen carry positions in the coming months,” Morgan Stanley’s currency strategy team wrote on Friday.
(The views expressed in this article are those of the author, a Reuters columnist)
(Author: Jamie McGeever; Editing: Michael Perry)
