As USDJPY probes back towards the lows of its “liftshaft” experience in early August, longer dated implied volatility is on the rise and skew favours puts over calls even more than before.
In our piece of 29thJuly (USDJPY and Gamma Trading) we recommended the use of short dated USDJPY put options as a way of benefitting from a combination of carry-trade unwind and risk-off as we went into a particularly intense week of data and Central Bank meetings. In that note, we referred back to our earlier (longer) piece of February (Turning Japanese, Feb 2024) to observe how carry trades in currencies have a predisposition to trade an “escalator / liftshaft” pattern. The Japanese Yen, as the principal funding currency, is often particularly vulnerable to violent reversals to previous carry-trading success.
The first week of August turned out to be a spectacular week of trend reversals. US equities led the way, but Japanese equities experienced their worst trading outcome since the crash of 1987, falling more than 20% in the four business days to Monday 5th August.
JPY (our currency expression of the risk-off mood) delivered over 8%, which is comparable on a volatility adjusted basis to the move in Japanese equities.
Both markets subsequently bounced but this note wants to make a discrete point.
At the time of writing (unlike the Nikkei) USDJPY is making a new closing low around 143.50 (although above the intraday lows of 141.70 on 5th August, for now.) The likelihood that carry-positions have had a chance to be entirely cleared out in the last month is slim, although nimbler actors have clearly significantly reduced their positions, as CFTC Commitment of Trader futures data attests. More likely we are now entering phase two where the narrative of policy divergence between a hiking BoJ and a cutting Fed begins to gain traction, keeping USDJPY under pressure until positions have been cleared out entirely.
What intrigues us (and what supports this thesis to some extent) is the fact that longer dated (12 month) USDJPY implied volatility is now higher than it was at the beginning of August and skew (the premium the market is prepared to pay for 25 delta puts over and above what they simultaneously pay for 25 delta calls) (known as Risk Reversals) also prices a higher premium for downside protection than it did during the market paroxysms of early August.
We should be delighted to hear from you directly if you would like a bit more colour on our research or guidance on the practical implementation of strategy suggested by these observations. Or indeed, if we can help with your currency management concerns more generally.
Please reach out to mi2research@mi2partners.com if we can be of any assistance.