Currently, the yen is stirring up the global market. After “hawkish” statements from central bank officials, hedge funds are betting on a further rise in the yen, and traders are setting up bullish options on the yen exchange rate.

On Thursday, Bank of Japan's “hawkish” member Naoki Tamura said that the Bank of Japan should speed up the pace of interest rate hikes to reach 1% as early as October 2025.

He also said that as the possibility for the Japanese economy to achieve the 2% inflation target on a sustainable basis increases, the conditions for the Bank of Japan to raise interest rates further are gradually being matured. Meanwhile, some hedge funds are increasing their bullish bets on yen in the options market. The yen is expected to continue this quarter's gains and maintain its position as “the world's best performing currency.”

The bullish yen is “in a broken position”

Recently, some traders said they are opening long positions against currencies such as the Japanese yen, the Australian dollar, the Swiss franc, and the offshore renminbi.

Since the end of June, the yen has appreciated by about 14% against the US dollar. With the support of expectations of interest rate cuts from the Federal Reserve and the closing of short positions in the yen, the yen's upward momentum is getting stronger.

Up to now, the yen is at 140.74 against the US dollar.

Citigroup Asia PacificForeign exchange transactionsDirector Nathan Swami said:

“I saw a demand from leveraged investors for falling options against other currencies against the yen.”

Expectations of interest rate hikes are heating up, and the yen is expected to boost

Next week will be a critical week for these options transactions. The market expects the Federal Reserve to cut interest rates next Thursday, while the Bank of Japan will announce the interest rate policy decision next Friday.

Meanwhile, Naoki Tamura's statement made the market more and more convinced that “after raising the policy interest rate to 0.25% in July, the Bank of Japan still intends to raise interest rates further.” Although the Bank of Japan will keep interest rates unchanged at the next meeting on September 20, surveys show that most economists predict that the Bank of Japan will further tighten its policy by the end of this year.

Analysts believe that if the Bank of Japan opens the door to the possibility of raising interest rates by another 25 basis points this year, the yen is expected to be boosted, but since pricing in the swap market is still lagging behind, the possibility of raising interest rates again is only 32%.

Jane Foley, head of foreign exchange strategy at Rabobank in London, said:

“Assuming that the Bank of Japan does not rule out the possibility of another rate hike around the end of the year next week, we expect USD/JPY to continue to move towards 140 over the next 3-6 months.”

Other strategists expect the USD/JPY exchange rate to fall further by the end of the year, and may even fall to 135.

Fluctuations in the yen affect options trading

Despite the recent rise in yen, its daily fluctuations may keep some hedge funds on the sidelines for a while. On Wednesday, the yen hit an eight-month high against the US dollar, but options trading volume at Depository Trust & Clearing Corp on that day was still one-third lower than the five-day average.

Ruchir Sharma, head of global foreign exchange options trading at Nomura Holdings, said he was surprised by the lack of leveraged participation in the fast money community. He stated:

“The “excessive cost” of downside options in other currencies against the yen may be the reason why some investors remain wait-and-see.”

Notably, when trading closed on Thursday, investors had to pay a 1.81% premium to hedge against the downside risk of USD/JPY over the next month. In contrast, the premium for upward risk was lower. In order to attract more hedge funds into yen options trading, Sharma believes that its actual volatility needs to be reduced. This, in turn, will affect the yenImplied Volatility.

“Recent data shows that a higher actual volatility base supports implied volatility,” said Citigroup's Swami. Lower implied volatility is good news for hedge funds, as it is one of the factors involved in the marketmakers' pricing formula. The reduction in implied volatility will help reduce the cost of buying options and make Qi more attractive to traders.