Hedge funds are currently making one of their largest bets against the Japanese yen in years, testing the tolerance of Japanese authorities as the currency approaches new depths not seen in 34 years.
Despite recent warnings from Tokyo about the "undesirable" nature of rapid exchange rate movements, there appears to be less inclination to engage in large-scale yen-buying interventions compared to 2022.
However, speculative market positioning remains a key factor that could prompt Tokyo to take action. Recent data from the Commodity Futures Trading Commission indicates that funds have increased their net short yen position to over 120,000 contracts, amounting to a leveraged bet of $10 billion on the yen weakening.
A short position reflects a belief that an asset's price will decline, while a long position indicates the expectation of a price increase. Hedge funds often take directional bets on currencies, aiming to align with long-term trends.
The yen has indeed experienced significant depreciation, with its value against the dollar dropping by 6% since the beginning of the year, reaching levels close to its lowest point since the 1990s.
This decline in the yen's value is primarily attributed to the substantial interest rate and bond yield gap between the United States and Japan, with expectations that this gap will persist due to potential delays in the Bank of Japan's policy normalization or lesser-than-expected rate cuts by the Federal Reserve.
This trend has proven to be lucrative for hedge funds thus far, evident in the recent surge in the net short yen position, which is the largest since November and the second largest in six years.
It's noteworthy that this position is even larger than during the periods of Japanese intervention in 2022, when the country spent a record $60 billion to stabilize the yen's value.
Since the beginning of the year, hedge funds have doubled their net short position, contributing significantly to the yen's ongoing decline towards new multi-decade lows.
Amid Japan's technical recession and persistently negative interest rates, while interest rates in other developed countries are at historic highs, the yen's weakness may be perceived as justifiable.
However, regardless of the underlying economic fundamentals, it's unlikely that Tokyo authorities would welcome the continued rapid expansion of speculative short yen positions.
Paraphrasing text from "Investing" all rights reserved by the original author.
