Yen’s unraveling risks collapse as traders pile on

The beleaguered yen has scope to slump further, with a drop of close to another fifth not out of the question, according to some strategists.

Societe Generale SA strategist Albert Edwards reckons the unraveling of Japan’s currency has the potential to take it to around ¥150 “as traders get the bit between their teeth.” That’s a level unseen since the last century, some 18% below the ¥122.42 per dollar the yen reached at one point on Friday.

“When the yen breaks, it moves sharply,” he wrote in a note to clients. “Despite being incredibly undervalued and oversold, the yen could yet plunge from here as FX traders, stupefied into boredom by the lack of FX volatility in recent years, see the yen’s decline as a trading opportunity and climb aboard.”

The recent surge in the dollar against the yen has been fueled in large part by the widening yield gap between the U.S. and Japan — which boosts the former and weighs on the latter — as traders adjust to an increasingly hawkish Federal Reserve.

Treasury yields have soared while those in Tokyo have been kept in check by a dovish Bank of Japan, which shows little inclination toward raising rates even as the fallout from the Ukraine war fuels inflation around the world.

The spread between the two country’s benchmark yields has jumped almost 60 basis points this year to 2.13%, around the highest since 2019. The difference between U.S. and Japanese inflation is even starker, with American consumer prices rising 7.9% year-on-year in February compared with just 0.9% across the Pacific.

Furthermore, Japan’s exposure to higher oil prices as a net importer means the yen has also lost some of its luster as a haven, failing to benefit much from periodic bouts of risk aversion that the war has prompted. That has exacerbated its poor performance, in particular against currencies of commodity producing nations.

The currency has fallen around 6% versus the dollar in 2022, the worst performer among developed-market peers. On Friday, it pulled back from the lowest since 2015 and headed for the first gain in six sessions to trade just under the 122 per dollar level by 4:15 p.m. in Tokyo.

A depreciation to the 150 per dollar mark isn’t out of the question, Edwards said. The strategist — known for bold and often bearish views on economies and markets — has suggested the yen could hit that level before, when it went through another period of weakness in 2014, but the currency bottomed just under 126 per dollar the following year.

Analysts surveyed by Bloomberg expect the yen to finish this year higher — at 116 per dollar.

Cheap valuation

Still, others point to the currency’s attractive valuation — it ranks cheapest among major peers on a real effective exchange rate basis, data compiled by Bloomberg show.

And a small change in rhetoric from policymakers — who have a tacit weak yen policy — could precipitate a large reversal in sentiment, according to Gavekal Research analyst Udith Sikand.

“The yen’s real effective exchange rate is at its most undervalued in nearly half a century, and open interest data from the currency futures market suggest the short yen trade is getting increasingly crowded,” Sikand wrote in a note Thursday. “There is little more dangerous than a safe bet in the foreign exchange market.”

Bank of Japan Gov. Haruhiko Kuroda said Friday that a weaker yen remains positive for Japan’s economy, although adding the central bank is continuing to watch currency moves carefully.

Speculative traders have held net short positions in the yen for about a year, data from the Commodity Futures Trading Commission show.

Commodity driver

For Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo, commodities remain key. The surge in raw materials prices raises the prospect of a spiral of yen weakness and Japanese trade deficits, he said.

“The yen has further to decline with a June 2015 low of 125 levels in sight in the near-term,” Sasaki said. “Over the longer run, it could extend its drop depending on how high commodities and energy prices climb.”