Will Yen Tank to New Lows?The Japanese Yen is one of the worst performing currencies in 2024. It has weakened 5.4% against the USD.
Forces have been stacked against Yen ever since the US Federal Reserve started raising interest rates at a record pace. In sharp contrast, ultra loose monetary stance from the Bank of Japan (BoJ) resulted in wide policy rate differential of 5% between short-term interest rates in both countries, which has contributed to Yen weakness.
The Yen made a recovery in December driven by a dovish Fed and hopes of BoJ exiting its ultra-loose policy in 2024. Yen rose to levels unseen since June 2023. However, thus far in 2024, the Yen has weakened as recent developments have cemented the need to maintain current loose monetary policy in Japan.
An Earthquake that struck Japan at the start of the year caused infrastructure damage. Stimulus will be required to fix that. Inflation in Japan is retreating to BoJ’s target range rapidly. Consequently, the central bank may see no rush to start hiking rates given uncertain recovery in economic growth.
This paper describes various forces at play and establishes a hypothetical trade setup using CME Japanese Yen futures to harness gains from weakening Yen.
BOJ’s MONETARY POLICY MAY STAY LOOSER FOR LONGER
1. Aid for Earthquake Relief: On January 2nd, a severe earthquake hit near Japan's Ishikawa prefecture , causing widespread destruction, damaging over 4,000 homes. The area continues to experience aftershocks, adding to the damage. Moody’s RMS predicts insured losses from the earthquake could be between USD 3 billion and USD 6 billion.
In response, Japan's Prime Minister Fumio Kushida plans to double earthquake relief funds to USD 7 billion in the next fiscal year to aid recovery efforts. Given the economic fallout, the BoJ is likely to maintain its lenient monetary policy in the near future.
2. Cooling CPI: Japan’s most recent CPI figures showed inflation cooling to 2.6% in December from 2.8% in November. That is the lowest reading since July 2022. Core CPI, which excludes fresh food, a measure referenced by the BoJ, fell to 2.3% from 2.5%. Inflation excluding fresh food and energy was 3.7% YoY, which was also lower compared to November’s 3.8%.
The core CPI reading is just a hair above BoJ’s target range of 2%. Inflation was driven lower by decline (11.6% YoY) in energy costs. The large drop was due to base effects of high energy prices last year. Services inflation remained unchanged at 2.3% fuelled by higher wages. That is positive news for the BoJ which aims to establish sustainable domestic-demand & wage-growth driven inflation.
With wage hikes from the Shunto negotiation in March-April still undecided, the BoJ is unlikely to pre-empt the exit from loose policy. Therefore, the next two policy meetings are unlikely to lead to a policy shift.
BoJ Policy Meeting calendar ( BoJ )
FED POLICY MAY NEED TO REMAIN TIGHTER FOR LONGER
Meanwhile, concerns are plenty in the US too. Inflation rebounded in December. Core inflation remains strong. Robust retail sales suggest consumers are resilient and still spending.
Jobs data from December was healthy. Recent jobless claims points to further strength in the labour market.
Put together, the Fed will not rush to cut rates as markets expect. This is exemplified by diverging market and Fed expectations for rate path. According to CME FedWatch tool (as of 22/Jan), markets are expecting 5 rate cuts in 2024 while Federal Reserve's dot plot suggested only 3 rate cuts would take place.
Both factors, from Japan and the US together, suggest fundamental Yen weakness and these conditions are expected to persist for longer.
YEN INTERVENTION WARNING
Despite the fundamental weakness, there are risks from betting against further Yen weakening.
As the currency weakened rapidly past 148/USD, the Japanese Finance Minister, Shunichi Suzuki, stated that the government is closely watching developments in the currency markets. He stressed the importance of stability and that market movements should reflect economic fundamentals.
Likelihood of intervention remains high and its impact on the Yen has been discussed previously .
MARKET METRICS
Options market activity points to a contrasting trend. Recent open interest change in CME Group Japanese Yen options have been tilted towards higher calls signalling hopes of Yen strengthening. Overall positioning points to a similar contrary trend.
CME Group Japanese Yen options OI change between 11/Jan and 19/Jan ( QuikStrike )
Despite the recent rally, implied volatility has not spiked significantly. They remain well below the highs seen in mid-December around BoJ’s policy meeting. Moreover, options skew remains elevated from its lows observed in late-October when the sentiment around Yen was heavily bearish.
CME Japanese Yen options CVOL index and options skew ( CVOL )
HYPOTHETICAL TRADE SETUP
The BoJ is unlikely to exit its loose policy stance any time soon against the backdrop of rapidly slowing inflation and uncertain economic outlook. In the US, a rebound in inflation might delay Fed’s rate cut decision. Collectively, this points to fundamental Yen weakness.
To limit downside exposure in case of intervention by Japanese officials in currency markets, a tight stop can limit losses.
The below hypothetical trade setup suggests a short position in CME Group Japanese Yen futures expiring in March (6JH2024) that provides a 1.55x reward to risk ratio. CME Group Japanese Yen futures have maintenance margin of USD 2,600 and provide exposure to 12,500,000 Yen.
• Entry: 0.0068115
• Target: 0.0066000
• Stop Loss: 0.0069500
• Profit at Target: USD 2,643 (68115 – 66000 = 2115 pips x 1.25)
• Loss at Stop: USD 1,731 (69500 – 68115 pips = 1385 pips x 1.25)
• Reward-to-Risk: 1.55x
MARKET DATA
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