Analysts pointed out that net short positions in yen recently reached the highest level since the financial crisis, and there is still plenty of room to close positions.
The NASDAQ evaporated $1 trillion on Wednesday, and the index entered a technical correction range. The decline in “Magnificent Seven Shares” naturally attracted the market's attention, but the most interesting change occurred in the yen.
The yen has risen 6% against the dollar since falling to a 40-year low earlier this month, making the yen the best performing currency in the world so far in July.
The yen rose by around 9% against currencies with higher interest rates such as the Mexican peso, Brazilian real, and Turkish lira, indicating that this was a typical arbitrage transaction to close. Interest rates in Japan are still low, which means it is a popular funding currency for various global currencies and fixed income transactions, which are currently being closed.
Furthermore, shorting the yen has been a popular macro-transaction for many years, because the Bank of Japan still resolutely maintains an extremely loose monetary policy while most of the other central banks around the world push up interest rates.
As a result, the net short positions of most investment funds in yen futures increased dramatically, recently reaching the highest level since the financial crisis.
The sudden surge in yen may cause some of these trades to close, the earnings of some macro hedge funds to shrink drastically, and add some extra enthusiasm to the market.
George Saravelos of Deutsche Bank believes that the main cause of large fluctuations in the yen is Trump's recent complaint about the strengthening of the US dollar. He specifically pointed out that the yen is a “major monetary issue,” which has led the market to re-evaluate the prospects for a “weak dollar policy.”
Saravelos notes that Japan is unique in many other ways:
First, the Japanese government is the only government in the G10 that is concerned that the exchange rate of the yen against the US dollar is too low.
Second, the yen is the only G10 currency that fundamentally does not match the mid-term valuation.
Third, there is a realistic prospect of potential policy interest rate convergence between the Bank of Japan and the Federal Reserve.
Finally, and most importantly, apart from official reserves, Japan's semi-official sector has an unusually large influence on capital flows, most notably the Government Pension Investment Fund (GPIF). We have been particularly emphasizing that GPIF portfolio assessments will increasingly correlate with the outlook for Japan in the coming months.
“We think the potential Trump administration is better able to influence the yen,” Saravelos said.
The sharp rise in yen is a sign of a safe haven environment, and at the same time, this scenario also seems to be increasing risk aversion.
According to Dutch International Group analysts, “The closing of short positions in yen has undoubtedly contributed to the global safe-haven environment.”
Although one can argue that the main drivers of the USD/JPY correction have multiple answers, including Japanese authorities' intervention, US interest rates, a correction in US technology stocks, and hints that the Trump administration will guarantee a weakening of the dollar, the core of the problem is that investors' positions are too biased to one side.
Speculative shorting of yen futures positions recently hit the highest level in nearly 20 years, and there is plenty of room to close them. Dutch International Group analysts made a rough calculation. On average, short positions in Japanese yen futures were established at 152.50 this year. Overall, these positions are almost underwater.