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The strong US dollar depreciation seen since mid-December seems to have been stopped for now and most recently the US currency was able to regain some lost ground again. There is only one currency in the G10 universe that did better since early February and that is the Japanese yen. Our currency indices illustrate that the JPY strength started at the exact same time as the recent corrections on the stock markets, which suggests that the yen was in demand as a safe haven as a result of increased risk aversion.
However, we have considerable doubts that the JPY strength is sustainable. The reason for the change of sentiment on the markets is the concern amongst market participants about a more active US monetary policy, i.e. a more rapid rise in US inflation resulting in quicker Fed rate hikes, which in turn could stifle the (global) economy. If this really was to be the case, the yen would have to be one of the currencies suffering most under this scenario in our view.
The reason behind this is the Japanese monetary policy. Compared with other central banks the Bank of Japan (BoJ) is still miles away from reaching its inflation target, in particular as it has also decided to stick to its expansionary monetary policy until inflation has even exceeded its 2% inflation target for some time so as to anchor inflation expectations at higher levels. At present underlying inflation in Japan stands at only roughly 0.5% though, so that one might assume that a normalization of monetary policy is nowhere in sight.
Lastly, JPY short positions are likely stretched of late. JPY appreciation due to the unwinding of JPY short positions could accelerate easily as a part of corrections. The IMM data show that JPY short positions as of Feb. 6 were 30% larger than the average of the past one year. In addition, anecdotal information suggests that there are stretched USDJPY long positions through Japanese FX margin trading in the markets.
Contemplating on above factors, one can short futures contracts of mid-month tenors with a view to arresting further downside risks.
Alternatively, those who are keen on optionality, stay short in a 1m USDJPY atm straddle vs buying a 1m 25D strangle.
Currency Strength Index: FxWirePro's hourly USD spot index has shown -91 (which is bearish), while hourly JPY spot index was at 81 (bullish) while articulating at 11:26 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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