As the U.S. Thanksgiving holiday approaches and market liquidity declines, the risk of the yen generating sharp swings is rising.
Renewed volatility in the yen’s exchange rate means that arbitrage traders may have trouble catching their breath over Thanksgiving.
From the South African rand to the Canadian dollar, traders who shorted the yen to arbitrage these currencies in order to invest in high-yield assets have suffered losses of more than 2% in the past five trading days alone. Looking at the last month, the picture is even tougher, with investments shorting the yen to long the Brazilian real and Swedish krona down about 4% and 3.4%, respectively.
With the U.S. Thanksgiving holiday approaching and liquidity declining, the risk of sharp yen swings is rising – testing the nerves of investors looking to make up losses or double their bets.
This is the kind of trading that will keep you up at night,” said Kyle Rodda, senior market analyst at Capital.Com. The market is going to be very nervous in the days leading up to the weekend, and if one takes on this kind of carry trade risk, there is little respite from the current volatility.”
The yen has risen more than 2% against the dollar this week, helped by a sudden rise in market expectations that the Bank of Japan is likely to raise interest rates again next month. The wide interest rate gap between Japan and other economies has been the cornerstone of the lucrative but potentially “explosive” yen-financed carry trade.
Strategists pointed out that the accelerated downward movement of the dollar against the yen this week, clearly showing that the 153 stacked options were easily digested, and there was hardly any defensive buying. Also, there was little room on the upside until a week later when a large number of options at 143.5 began to be centrally liquidated.
The potential for President-elect Trump to amplify market volatility by making new social media posts has also dampened the appeal of the yen carry trade, which typically thrives in low volatility environments. The Mexican peso rose more than 1 percent against the yen on Thursday after Trump posted that he had a very productive conversation with the Mexican president.
Rodrigo Catril, a strategist at National Australia Bank Ltd.’s Sydney branch, said, “Arbitrage traders don’t like uncertainty. Hence, the sell-off was justified by uncertainty over tariffs and the increasing likelihood of Trump’s sudden policy statements on social media.”
Another key factor was the sharp change in expectations for Japanese interest rates. Overnight index swaps show that investors now expect a 60% probability of a rate hike by the Bank of Japan in December, compared with 32% earlier this month.
Jane Foley, head of FX strategy at Rabobank in London, wrote in a research note that “the market has been encouraged by the possibility of a rate hike by the BOJ in December and the latter may be reluctant to disappoint.”
