Yen Surge: A Currency Jump and Its Global Consequences

A dramatic surge in the Yen is currently shaking global markets and is on track to mark the best month of the year for the Japanese currency. This is happening against the backdrop of upcoming meetings of the Japanese and U.S. central banks, which suggest further volatility. In July, the Yen jumped 4.7 percent against the dollar. This development was fueled by the prospect of an interest rate hike by the Bank of Japan (BoJ) on Wednesday. Such an increase would narrow the large gap with the Federal Reserve's borrowing costs, which had driven the Yen to a series of multi-year lows. Expectations for Fed rate cuts have also increased after U.S. inflation eased earlier this month. The recovery of the Yen was also accelerated by the unwinding of popular 'carry trades.' In these trades, investors had borrowed in Yen to buy higher-yielding currencies, thereby driving bets against the Yen to the highest level in about two decades. Analysts say that investors seeking to limit their losses from poorly performing carry trades were forced to sell other assets, leading to a sharp sell-off in global technology stocks. "The foreign exchange market is moving everything right now because Yen-funded carry trades were among the most popular this year – closing those positions is also impacting other risk positions," said Athanasios Vamvakidis, global head of FX strategy at Bank of America. Despite the stabilization of the Yen on Friday, currency traders expect volatility to increase in the coming week as markets prepare for the BoJ's rate decision and adapt to a global shift in risk appetite as well as the massive unwinding of speculative currency positions. These predictions were made by traders in Tokyo at three major banks at the end of a week in which the Yen rose from 157.5 Yen per dollar to 153.71 Yen. However, traders also warned that a decision by the BoJ on Wednesday to keep interest rates unchanged could trigger a rapid reversal for the Yen, causing it to fall back toward the low of 161 Yen per dollar, where Japanese authorities reportedly intervened in mid-July. "Next week could be really interesting for the Yen, as the starting position before the BoJ meeting is very different given the clear shift in market sentiment towards the carry trade," said Benjamin Shatil, FX strategist at JPMorgan in Tokyo. "There are still many short positions on the Yen that could be unwound if we see a move through 152. At the same time, if the BoJ makes no significant announcement, the Yen could fall again without much resistance," he added. Swap market traders are divided over the prospect of the Bank of Japan raising its key interest rate by 0.15 percentage points to 0.25 percent next week, with the probability at a quarter earlier this month. Additionally, U.S. policy influences play a role, including comments from Donald Trump that the U.S. has a 'big currency problem' due to the weakness of the Yen and Yuan, signaling that he might consider various options to weaken the dollar if he wins the presidential election in November. This coincided with a massive sell-off on Wall Street, led by technology stocks. "The most popular trade among fund managers was long positions in tech stocks and short positions in Yen in the FX sphere. This week, we’ve seen the unwinding of the most popular trades, and I’m sure there was some overlap," said Chris Turner, global head of research at ING. BoJ watchers believe that the currency movements have put the central bank in a difficult position, as the current economic situation seems to justify a small rate hike. However, if the BoJ decides against an increase, analysts could interpret this as a reactive move because the Yen is now stronger. "In the last two years, many have made a lot of money with short positions on the Yen. There will be a tendency to re-enter if the BoJ does not raise rates," said Turner.