As the foreign exchange market navigates turbulent waters, investors are turning to alternative strategies to capitalize on the Japanese yen's strength.
With the Bank of Japan (BOJ) embarking on a rate-hike cycle, traders are increasingly using European currencies instead of the dollar to fund their yen positions, aiming to sidestep the unpredictability surrounding U.S. trade policies.
Shifting Away from Dollar-Based Trades
The uncertainty surrounding Donald Trump's proposed trade tariffs has left traders questioning the dollar’s trajectory.
While some view these tariffs as a bullish driver for the greenback, others suspect they are mere negotiation tactics. This ambiguity has prompted firms to explore alternative strategies that avoid direct exposure to the USD/JPY pair.
Leading asset managers, including Vanguard Asset Management, Russell Investments, RBC BlueBay Asset Management, and Candriam SA, are employing creative approaches. These firms are shorting the euro, Swiss franc, and British pound against the yen, a strategy that offers both higher returns and reduced exposure to U.S. political risks.
BOJ’s Rate Hike Boosts Yen’s Appeal
After years of being perceived as a low-yielding currency, the yen is now poised for a significant shift. The BOJ has signaled further rate hikes beyond the current 0.5%, acknowledging Japan's economic resilience and departure from deflationary pressures.
In contrast, many European economies are preparing for aggressive rate cuts to stimulate growth.
The European Central Bank (ECB) is expected to reduce rates by at least three quarter-point cuts this year, compared to just one from the U.S. Federal Reserve. This divergence strengthens the case for shorting the euro against the yen.
Yen Surges Against European Currencies
Year-to-date, the yen has risen approximately 2% against the Swiss franc, sterling, and the euro. This marks the strongest start to the year for the yen against these currencies since 2017. Analysts at Citigroup Inc., Rabobank, and Danske Bank A/S forecast the euro to decline from 160 yen to below 150 by year-end, with Danske Bank predicting a drop to 141 yen—a 12% depreciation.
Options Market Signals Bearish Sentiment for European Currencies
Risk reversals in the options market indicate growing bearish sentiment toward European currencies against the yen. Swiss franc-yen risk reversals are at their most negative levels in two months, while investors are actively hedging against a decline to 160 yen. Switzerland’s potential return to negative interest rates further supports this bearish outlook.
Meanwhile, euro-yen volatility remains relatively subdued compared to the euro-dollar pair. The narrowing spread between the two suggests traders prefer yen exposure without engaging in dollar-related risks.
Investment Strategies: Yen as a Preferred Long
Fund managers like Mark Dowding, Chief Investment Officer at BlueBay, are buying the yen against the euro and the pound as a way to navigate through U.S. trade uncertainties. Ales Koutny, Head of International Rates at Vanguard Asset Management, has been long the yen against the franc, euro, and even the South Korean won since December.
“The yen used to be one of our favorite shorts,” Koutny noted. “It has now become one of our preferred longs.”
Key Takeaways for Forex Traders:
The BOJ’s tightening policy supports yen strength against European currencies.
European rate cuts are likely to weaken the euro, franc, and pound against the yen.
Options market signals increased bearish sentiment for European currencies.
Investors are avoiding dollar volatility by opting for yen trades via European cross pairs.
With Japan’s economic outlook strengthening, traders looking to capitalize on forex opportunities should consider yen-based strategies that hedge against U.S. political risks while benefiting from global rate differentials.
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