Japan's yen is a compelling trade but comes at a cost

Reuters

03-07-2025

SINGAPORE, July 03 (Reuters) - Global investors are unwinding their wagers on Japan's yen rising quickly as a cautious central bank, a trade war and the prohibitive cost of holding the currency sour one of the year's most popular trades.
Most analysts and real money investors remain convinced the yen will eventually appreciate as Japan shifts away from ultra-low rates. But pitted against this conviction are short term headwinds, including the lack of progress on a trade deal with the United States and uncertainty surrounding Japanese national elections.
Monetary policy has become the yen's biggest sticking point after the Bank of Japan (BOJ) has hinted it is loath to raise rates again this year, having done so in January, before it can gauge the full impact of U.S. President Donald Trump's sweeping tariffs.
James Athey, London-based fixed income manager at Marlborough, has reduced his long yen positions versus the dollar because he sees short-term positioning in the currency and the BOJ's "intransigence" as headwinds.
"Ultimately we do still see numerous long-term tailwinds for the yen, it's just about managing the journey amongst this uncertainty and volatility," he said.
Investors still hold net long positions in the yen worth $11.41 billion, although that's drastically lower than the record $15.7 billion at the end of April, weekly data from the U.S. markets regulator showed.
By virtue of low Japanese yields and huge offshore investments, the yen has historically been sensitive to overseas interest rates. The yawning gap between the U.S. and Japanese interest rates in the past few years had driven the yen to record lows, prompting costly interventions from Tokyo.
That gap also makes owning the yen, whose bonds pay 0.5% on average, using U.S. dollars that cost upwards of 4%, an expensive proposition for investors. If the yen depreciates, it's a double-whammy.
Bo Zhuang, global macro strategist for Loomis Sayles, an affiliate of Natixis Investment Managers, said investors expected at the beginning of the year the long yen trade would work well over three to six months.
"But now it's about 'oh well, maybe it will last more than that' and the cost of holding such a position might be too high for them to recover."
At the start of 2025, market expectations were for Japan to raise rates quickly and for the U.S. Federal Reserve to start cutting rates later in the year.
Yen buyers were rewarded when Trump's sweeping trade tariffs in April jolted markets, shook investors' faith in the U.S. dollar and caused a swift 9% rise in the yen from levels near 160 per dollar, its strongest first-half performance since 2016.
But the yen has been meandering since then as the BOJ turned cautious.
"The trade faces a negative carry because of the interest rate differential and needs to be actively managed," said Matthias Scheiber, senior portfolio manager at Allspring Global Investments, who reduced his long yen position.
But Scheiber reckons any sell-off in yen is an opportunity to buy it.
"We still like the trade, despite the fact that over the last couple of weeks, it was basically trading flat," said Scheiber, who is also the head of the multi-asset solutions team at Allspring.
In the derivatives market too, options betting on a higher yen cost more, in a sign of bullishness on the currency. Interest in low-cost yen options that deliver outsized payoffs if the currency strengthens sharply has jumped.
The yen's trajectory will heavily depend on where U.S. duties end up after Trump this week cast doubt over a possible deal with Japan. He also suggested a tariff of 30% or 35% on imports from Japan - well above the previous 24% tariff rate.
A high tariff rate will stifle Japan's major auto exports and make the BOJ's path towards shifting away from decades of ultra-low rates even more perilous.
"I think the yen is waiting for catalyst in terms of how the US-Japan trade negotiations go because I think that's a road block for policymakers," said Moh Siong Sim, currency strategist at Bank of Singapore.
"Yen has always been alternating between super excitement and super disappointment."