Japanese Yen Arbitrage Trading: Comprehensive Recovery Still Difficult in the Short Term
2024-08-19
■ The appreciation of the Japanese yen before August 5th has led financial markets to believe that yen arbitrage trading has temporarily ended.
■ Speculators may again turn to selling Japanese yen, but a comprehensive recovery depends on developing US-Japan financial policies.
After reaching a high of 161.99 yen on July 3rd, the US dollar/Japanese yen exchange rate fell to a low of 141.66 yen on August 5th, a drop of about 20 yen within a month. Afterward, due to the easing of concerns about a US economic recession, the exchange rate rebounded to the low range of 149 yen. During this period, data from the US Commodity Futures Trading Commission (CFTC) showed that the net selling position of the Japanese yen in the non-commercial sector, which reflects the trading movements of some speculators, decreased to approximately 11000 contracts by the end of August 6th. Compared to the approximately 184000 contracts that ended on July 2nd, over 90% of the yen selling positions have been released. This situation has led the market to believe that the yen arbitrage trading that previously swept the foreign exchange market has temporarily ended.
The situation in the currency options market also indicates that speculators are liquidating their yen sell positions. Usually, the prerequisite for generating profits from yen arbitrage trading is a market environment with relatively small exchange rate fluctuations. In this case, the volatility of the currency options market often remains at a low level. For example, the two-cycle volatility of the US dollar against the Japanese yen dropped to around 5.8% in February of this year. However, during the yen appreciation before August 5th, the volatility rose to around 20%, the highest level since March 2020, indicating that the market environment was not conducive to yen arbitrage trading. In addition, the "risk reversal" indicator shows a marked preference for the direction of yen appreciation, known as the "yen call option premium," which has reached levels since April 2020.
Will speculators tend to buy yen or sell yen next? I believe that speculators are more likely to be inclined to sell the Japanese yen. Indeed, interest rates in the United States may decrease, while those in Japan may increase, gradually narrowing the US-Japan interest rate differential. However, the current policy interest rate differential between the United States and Japan is still as high as 5.25%, which means that long-term holdings of buying yen and selling dollar positions will lead to increased losses due to the interest rate differential. Therefore, speculators do not have an environment in which to maintain yen buying positions. On the other hand, the currency options market has not shown a stable situation suitable for building yen sell positions as it did in June this year. Although concerns about a US economic recession have eased, many market participants still hope to observe the prospects of US interest rate cuts and Japanese interest rate hikes, especially regarding policy direction before next year. Therefore, speculators will find it difficult to fully resume yen arbitrage trading before the monetary policy meeting of the US and Japanese central banks in late September. The first thing to consider is whether the US dollar/Japanese yen exchange rate can break through the 200-day moving average (151.39 yen). From July 2023 to last month, the 200-day moving average has been a vital support line for the US dollar to Japanese yen exchange rate. Therefore, breaking through this line will become the first key point in the depreciation process of the Japanese yen.
■ Speculators may again turn to selling Japanese yen, but a comprehensive recovery depends on developing US-Japan financial policies.
After reaching a high of 161.99 yen on July 3rd, the US dollar/Japanese yen exchange rate fell to a low of 141.66 yen on August 5th, a drop of about 20 yen within a month. Afterward, due to the easing of concerns about a US economic recession, the exchange rate rebounded to the low range of 149 yen. During this period, data from the US Commodity Futures Trading Commission (CFTC) showed that the net selling position of the Japanese yen in the non-commercial sector, which reflects the trading movements of some speculators, decreased to approximately 11000 contracts by the end of August 6th. Compared to the approximately 184000 contracts that ended on July 2nd, over 90% of the yen selling positions have been released. This situation has led the market to believe that the yen arbitrage trading that previously swept the foreign exchange market has temporarily ended.
The situation in the currency options market also indicates that speculators are liquidating their yen sell positions. Usually, the prerequisite for generating profits from yen arbitrage trading is a market environment with relatively small exchange rate fluctuations. In this case, the volatility of the currency options market often remains at a low level. For example, the two-cycle volatility of the US dollar against the Japanese yen dropped to around 5.8% in February of this year. However, during the yen appreciation before August 5th, the volatility rose to around 20%, the highest level since March 2020, indicating that the market environment was not conducive to yen arbitrage trading. In addition, the "risk reversal" indicator shows a marked preference for the direction of yen appreciation, known as the "yen call option premium," which has reached levels since April 2020.
Will speculators tend to buy yen or sell yen next? I believe that speculators are more likely to be inclined to sell the Japanese yen. Indeed, interest rates in the United States may decrease, while those in Japan may increase, gradually narrowing the US-Japan interest rate differential. However, the current policy interest rate differential between the United States and Japan is still as high as 5.25%, which means that long-term holdings of buying yen and selling dollar positions will lead to increased losses due to the interest rate differential. Therefore, speculators do not have an environment in which to maintain yen buying positions. On the other hand, the currency options market has not shown a stable situation suitable for building yen sell positions as it did in June this year. Although concerns about a US economic recession have eased, many market participants still hope to observe the prospects of US interest rate cuts and Japanese interest rate hikes, especially regarding policy direction before next year. Therefore, speculators will find it difficult to fully resume yen arbitrage trading before the monetary policy meeting of the US and Japanese central banks in late September. The first thing to consider is whether the US dollar/Japanese yen exchange rate can break through the 200-day moving average (151.39 yen). From July 2023 to last month, the 200-day moving average has been a vital support line for the US dollar to Japanese yen exchange rate. Therefore, breaking through this line will become the first key point in the depreciation process of the Japanese yen.