Macro and Vol Commentary
The yen weakened to a 7-month low against the dollar and a 15-year low against the euro, given the divergent outlook between the BOJ and the rest of the major central banks. With the next round of central bank meetings not until late July, what is the outlook for EURJPY in the near term?
Japanese Economy
- While monetary policy outlook has played a key part in sentiment in recent months, a weakening macroeconomic background has added fuel to the fire of recent yen weakness.
- The trade deficit has continued to widen, reaching record figures of JPY21.7tr in March, as commodity prices climbed, and export growth slowed.
- Retail sales fell by 1.2% m/m in April, the lowest reading since early 2021, as optimism earlier seen this year is waning.
- Indeed, we expect the growth seen in Q1 to slow going into Q2’23.
- At the same time, the idea around core inflation coming down in the H2’23 is getting increasingly challenged by each inflation data release.
- In May, CPI reached 3.2% y/y, broadly unchanged relative to data seen so far this year; core reading is also underscoring inflation stickiness, averaging at 3.48% y/y over the last five months.
- Inflation continues to remain above-target and outpace expectations, and we expect this to be reflected in revised BOJ forecasts.
- Such a revision could be used to justify changes to yield-curve control, which would likely enable long-term rates to rise further.
Bank of Japan
- Despite Ueda entering the office in April, May’s meeting showed that officials are not yet ready to take action in regard to monetary policy but remain on standby to act if necessary.
- With the ECB bets for further tightening building, pressure is once again mounting on the BOJ, which is scheduled to meet on July 28th.
- The ECB's Lagarde reiterated the hawkish sentiment in recent days, stating that the central bank still has ground to cover, and now, the market is pricing in 48bps until the end of the year, beyond the increases seen from the Fed.
- For the BOJ, the market does not see a rate change, with only 6bps priced in through forward swaps, leaving the rate at -0.1% until 2024.
- This suggests that investors are convinced that the low-yield environment will continue in Japan for an extended period of time.
- As a result of BOJ’s negative-rate policy, the yen’s status as an attractive currency for carry trade skyrocketed, further adding to its weakening trend.
- Speculations are growing that the central bank may tweak its yield-curve control programme this summer to make it more sustainable.
- It is the September meeting that traders increasingly see as a potential risk event, given that a measure of 3m yen volatility is rising compared to the 1m.
- However, the case is also building for intervention measures to be implemented later this year.
- In 2022, a volatile yen brought about $62m of government intervention to support the currency, helping the currency to come down from the elevated levels.
- Despite the pair trading above these levels markets seem less worried about the impacts of policy control, given that the 1-month implied volatility is below levels seen in the run-up to last year’s intervention.
- We believe for a policy of this scale to be enacted again, policymakers will watch out for a combination of pricing levels and the speed of the decline. In the meantime, 160 holds as a firm resistance level.
As the yen edges closer to 160 against the euro, there are growing risks of an intervention by the government. In the meantime, following the recent array of central bank meetings, investors have pretty much placed their bets on the path of further tightening. While this is still subject to fluctuations in the coming months, the divergence with the BOJ is likely to widen further, pushing the currency pair to test the 158 level. Still, the panic that we saw in 2022 is unlikely to materialise given that the global tightening cycle is approaching the endgame, most likely later in Q3 2023. A lot will hinge on the scale of the hike at the July meeting from the ECB following a 25bps hike in June. Given that both central banks have meetings between the 27-28th of July, we expect to see heightened volatility ahead and during the events.
Sources: Ministry of Economy Trade and Industry Japan, Ministry of Internal Affairs and Communications, Bank of Japan
Volatility Comment
Yen has weakened considerably against all majors, reaching a 15-year low vs the Euro as the new governor Ueda continues to maintain his predecessor’s policy of yield curve control. Despite Yen’s significant depreciation, volatility has retraced back toward the bottom of range from the last 15 months; circa 10.3% at time of writing. This presents us with a good opportunity to buy vol. Momentum in EURJPY is strong and we expect the trend to continue amid diverging rates outlook; However, Yen is approaching levels which will make BOJ uncomfortable and could lead to intervention as we witnessed back in 2022. Therefore, we have opted to buy a American Knock-In Put option, cost of the option is relatively small compared to the potential payoff if our scenario plays out.
EURJPY Trade Idea
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Buy KI Put with strike 157 with up and in KI barrier 163
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Expiry 3M : 27/09/2023
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Spot Ref 157.50
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Premium Cost Circa 21K Euro’s
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For reference Vanilla equivalent would be circa 228k USD premium cost
Positioning Charts
EURUSD Vanilla Positioning Data 15/06/2023 - 22/06/2023
EURUSD option positioning remained broadly unchanged in the week ending June 29th, only with upside and downside covers growing further down the curve. At the same time, near-term expiry has also widened slightly, into 1.06-1.12, suggesting markets are becoming uncertain about the direction of the pair move. Both the number of calls and puts have grown, highlighting increased volumes, but the ratio remained broadly balanced. With that in mind, we think that the pair is likely to remain range-bound in the near term.
EURUSD Vanilla Positioning Data 22/06/2023 - 29/06/2023
USDCNY Vanilla Positioning Data 15/06/2023 - 22/06/2023
USDCNY option positioning widened significantly in the week ending June 29th, with expiries extending below 6.90. Most of the options below this level are calls, suggesting market remains hesitant about the pair falling below this level, and instead investors are keen to purchase on a dip. Within the 7.10-7.30 range, the market remains broadly balanced, suggesting uncertainty about the price direction further down the curve.
USDCNY Vanilla Positioning Data 22/06/2023 - 29/06/2023
EURJPY Vanilla Positioning Data 15/06/2023 -22/06/2023
EURJPY option positioning shifted above 150 in the week ending on June 29th, as the pair continued to break new highs. The next resistance level stands at 160 and the market sees little appetite above this level as of now. This created a tight expiry range between 150-160, with the number and size of notional being slightly greater for puts, reaffirming market's belief of a strong resistance level. We expect upside momentum to stall in the near term, as the pair approaches the 160 level.
EURJPY Vanilla Positioning Data 22/06/2023 - 29/06/2023
Charts and Tables
FX Expiries
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Weekly Change
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