Column-Irrational Exuberance? Funds’ yen longs hit 8-year high: McGeever By Reuters

By Jamie McGeever

ORLANDO, Florida (Reuters) – Hedge funds are the most bullish on the Japanese yen in eight years, but as their “long” positions grow and the currency strengthens, yen volatility is also rising.

This raises the question of whether the huge change in the yen’s fortunes recently, reflected in the rapid reversal of speculators’ positioning as much as anything, is “too much too soon” and that a period of consolidation is at least warranted.

The yen is up 15% against the dollar since mid-July and is now slightly stronger against the greenback year to date. Commodity Futures Trading Commission data shows that hedge funds and speculators now hold the largest net long yen position since October 2016.

Data for the week ended Sept. 10 shows funds held a net long position of 55,770 contracts, effectively a bullish bet on the currency worth nearly $5 billion.

Measured in dollars, that is the biggest long since February 2021. Measured by net CFTC contract holdings, it is the highest level of yen funds in eight years.

A long position is essentially a bet that an asset will increase in value, and a short position is a bet that its price will decrease.

The current positioning of hedge funds is worth putting into context. CFTC data shows that since yen futures were launched in 1986, funds have only held a larger net long position for 33 weeks. And 16 of these were concentrated between February and October 2016.

Whether they are reducing their net shorts or expanding their net longs, the funds’ positioning has been increasingly positive for the yen for 10 consecutive weeks. The last time they went on a streak like this was in 2012.

There are fundamental economic reasons for this, the most compelling of which is the divergent policy paths the US and Japanese central banks are taking – the Fed is about to start its rate-cutting cycle, the Bank of Japan has already started a hiking cycle historical, but provisional.

Rate traders expect the Fed to cut rates by about 250 basis points by the end of next year and the BOJ to hike by 30 bps.

The two-year and 10-year yield spreads between the US and Japan are now 320 bps and 280 bps respectively, both the narrowest in two years. At the end of last year, they were over 500 bps and 400 bps respectively.

Much of this narrowing will already be in the price of the exchange rate. Notably, the yen is now slightly higher against the dollar this year and looks poised to break above the 140.00 per dollar level soon.

But forex traders know that the strength of the yen, especially sudden bursts of appreciation, is often associated with bouts of investor risk aversion, economic or financial market turbulence, and rising demand for “safe” assets in times of uncertainty.

Are any of these conditions in play now? Maybe. The yen’s rise has been strong and fast as traders have written off the so-called “yen trade” and uncertainty around the economic outlook from the US, the Fed and the BOJ is high.

No wonder, then, that yen volatility is also high. Three-month USD/Yen implied volatility is now around 12.00, the highest since last March, and one-month implied volume recently rose to 15.00 for the first time since January last year.

The Fed and BOJ deliver their latest policy decisions and outlook this week, and with speculative positioning just as stretched, yen volatility may remain higher for a bit longer.

(The opinions expressed here are those of the author, columnist at Reuters)

(By Jamie McGeever; Editing by Sonali Paul)