Yen carry trade sees a major reversal as the hottest Carry trade experiences a stampede

The Japanese yen has surged. Expectations of a rate hike by the Bank of Japan at the end of the month and a global stock market crash have led to a crowded unwinding of yen short positions, resulting in a stampede in this year's hottest Carry trade.

Why has the Japanese yen appreciated significantly?

1. The Bank of Japan may hike rates at the end of the month

Yesterday afternoon, Reuters reported that the Bank of Japan will consider a rate hike next week and announce a plan to halve its bond purchases in the coming years.

From Japan's inflation perspective, both core inflation and inflation expectations surveys indicate a high likelihood of a rate hike this month. In June, core CPI excluding food and energy rebounded from 2.1% to 2.2%. The Tankan survey released by the Bank of Japan at the beginning of July for the second quarter showed that companies expect the year-on-year CPI increase five years from now to rise from 2.1% to 2.2%.

Currently, the market's expectation for a 10 basis point rate hike by the BOJ in July has reached 71%.

2. Global stock market plunge triggers safe-haven inflows into Japan

Recently, global stock markets have been declining, triggering a sharp drop in USDJPY and crossJPY due to risk aversion. Yesterday, tech giants Tesla and Google reported lower-than-expected earnings, leading to a 2.3% decline in the S&P 500 index and a 3.6% drop in the Nasdaq 100 index, marking the largest single-day decline in a year and a half.

How large are the current yen carry trade positions?

Let's take a look at the size of yen short positions in carry trades from the three major traders in the yen market (Fast money, Real money, Retail).

1. Fast money: CFTC yen net shorts retreat from historical extremes

According to CFTC's position data, speculative net short positions in the yen reached a historical extreme of 184,000 contracts at the end of June. However, due to a cooling U.S. CPI and Bank of Japan intervention, speculative yen shorts decreased by 31,000 contracts in the week ending July 16, marking the largest weekly change in recent years

2. Real Money: Historic Low in Hedging Ratio for Japanese Insurers

According to the financial results announced by 9 major life insurance companies in Japan at the end of the fiscal year 2023, as of the end of March 2024, the foreign exchange hedging ratio for holding foreign currency assets has dropped to 43.8%, approaching a historic low (for comparison, China's latest settlement rate in June is 58%).

Under the expectation of a rate cut in the United States and a rate hike in Japan, the unhedged overseas assets may increase the foreign exchange hedging ratio, leading to a strengthening of the Japanese yen.

3. Retail Investors: Surge in Investment in Overseas Assets through NISA this Year

According to data released by the Japanese Ministry of Finance, the net purchase of overseas investments by domestic investment trust management companies in Japan from January to June has exceeded 6.7 trillion yen, and most of these investments are without foreign exchange hedging. In the first half of this year, benefiting from the depreciation of the US stock market and the Japanese yen, these retail investors can be described as a double win.

With recent declines in overseas stock markets, some overseas investments are flowing back to Japan, requiring the selling of US dollars and buying Japanese yen, hence we often see the scenario of "European/American stocks falling + Japanese yen rising" during the London and New York trading sessions.

Subsequent Market Judgement

USD/JPY and crossJPY are highly trending products in the foreign exchange market. From experience, it is important to:

Follow the trend!! Never go against it!!!

From a technical perspective, after USDJPY broke below the support of the 50-day and 100-day moving averages, the next support level is at the 200-day moving average of 151.5.

Therefore, it is expected that the Japanese yen may remain relatively strong before the BOJ meeting on July 31. However, there may be a "buy the rumor, sell the fact" trend after the meeting.

(Reference can be made to the yen trend after the Bank of Japan's policy adjustment announcements in July 2023 and March 2024)

Author: Fang Yuqi, Source: Good Morning Market, Original Title: "Japanese Yen: Carry Trade Reversal"