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Summary
- Since the Japanese Ministry of Finance (MoF) bought JPY on 11 July, USD/JPY has declined ~5.75%, its biggest two-week drop since late last year.
- USD/JPY is now trading at its lowest level since early May (~152.50).
- Much event risk exists for USD/JPY in the next week. The Bank of Japan (BoJ) updates monetary policy on 31 July, as does the US Federal Reserve (Fed), with the US jobs report to be released on 2 August.
Market Implications
- With USD/JPY having fallen so far, so fast, we like scaling-in to a long position. We do so cautiously in smaller-than-normal sizes given the event risk next week
- The MoF may take advantage of recent USD/JPY downside to intervene again.
Fall in USD/JPY Over Past Fortnight Has Been Aggressive
Price action in USD/JPY has been dramatic since the MoF intervened on 11 July.
In the past two weeks, the pair has free-fallen from a high just below 162 to today’s low (~152.50 at the time of writing, ~152.25 the low).
On a trade-weighted basis, USD/JPY is on course this week for its biggest weekly drop since late 2022, and its biggest fortnightly drop since late 2023.
Chart 1: USD/JPY Spot Rate = Orange Line
MoF and BoJ Have Given USD/JPY Longs Second Thoughts
While the MoF intervention was the initial catalyst for the recent USD/JPY downturn, next week’s BoJ monetary policy update is also important in the pair’s price action, especially this week.
As we argued yesterday, next week’s BoJ meeting is live.
The market currently prices around a 90% probability of a 10bps hike, or a 60% chance of a 15bps hike.
We think the BoJ will hold rates next week and argue September remains more likely for the next Japanese rate hike.
However, the positioning unwind should dampen volatility if the BoJ hikes next week. This may be a classic sell-the-rumour, but-the-fact scenario for USD/JPY.
Risks may tilt to JPY downside should a hike not occur.
The BoJ may also enact a less hawkish slowdown in JGB purchases.
We think consensus leans towards a new purchase pace of JPY 5tn slowing to JPY 3tn in two years from the current pace of JPY 6tn.
Lastly, event risk is increasingly priced into 1m risk reversals (riskies), which have fallen as the BoJ meeting approaches. Skew is now the lowest since the end of April when the BoJ last updated its forecasts and has increasingly deviated from 3m riskies (Chart 2).
Should the BoJ stand pat at next week’s meeting or slow JGB purchases at a more modest pace than the market expects, disappointment here will probably lead to JPY weakening and JGB yields falling.
Sharp Positioning Unwind
JPY shorts have unwound at the fastest pace in over four years.
Leveraged and asset manager positions fell 72,500 contracts over the past two weeks – around 8% of open interest. Yet overall positioning remains short JPY, with net shorts around 31%.
We have highlighted that hedge fund and real money have cut JPY shorts substantially.
With short JPY positioning less crowded than a few weeks ago, the likelihood of a further short-JPY squeeze is diminished.
Hedge funds and real money remain short JPY. Nonetheless, they are not nearly as short as they were, as many short positions have been squared-up.
We Like Buying Dips, but Be Careful and Nimble
Last week we advocated a USD/JPY strategy to buy-on-dips below 154, arguing support for the USD/JPY carry trade looks likely to continue.
A main reason for this is we think the BoJ will be less hawkish than the market currently expects.
Moreover, as Macro Hive’s Dominique Dwor-Frecaut maintains, pricing for the Fed is now too dovish.
The market now prices roughly three 25bps Fed cuts for this year, including a 25bps cut in September.
Dominique argues only one 25bps insurance cut is more likely and will only occur after the election, in November or December.
Overall, we think a less hawkish BoJ and a less dovish Fed supports buying dips in USD/JPY.
We advise caution, though.
Much near-term event risk exists (Fed and BoJ next week, US jobs report) and the threat of further MoF intervention always looms.
Therefore, scaling into a long position in smaller size is the most prudent action. Being nimble in the coming weeks is critical.
Richard Jones writes about FX and rates markets for Macro Hive. He has traded and invested in interest rate and FX market portfolios spanning three decades, both on the buy-side and sell-side.