Investors seeking profits from the dollar-yen's volatility may encounter limited movements, with the currency pair poised between increasing intervention risks and uncertainties surrounding U.S. interest-rate expectations. One-month implied volatility for the dollar-yen, indicating expected movement, could hit its lowest point since March 2022, driven by a narrowing daily trading range influenced by conflicting factors.
The pair is seemingly caught between the Ministry of Finance hinting at intervention from the topside and the Bank of Japan downplaying rate hike possibilities, providing support on the downside, according to David Forrester, a senior foreign exchange strategist at Credit Agricole CIB in Singapore.
"In this range-bound scenario, the focus is on carry," remarked Bank of Singapore strategist Moh Siong Sim. He acknowledged that optimism for a yen rally was dampened by last week's data revealing an unexpected recession in Japan.
Market Eyes Dollar-Yen Breakout Amidst Volatility
While one-month implied volatility surged to 8.14% last week ahead of the BOJ's monetary policy decision on March 19, this rebound may be short-lived. Forrester noted that the reduction in Federal Reserve rate expectations, prompted by robust U.S. inflation data, also limits the dollar-yen's downside. Last week's most extensive daily trading range was a mere 0.75 yen, significantly lower than the over two yen seen in early January. The yen is trading around 150.50 against the dollar in Asia on Monday.
As the currency pair appears susceptible to getting trapped around 150, option traders closely monitor Japan's inflation data on February 27, hoping it could catalyze a breakout from the narrow range. BOJ Governor Kazuo Ueda's recent expression of confidence in achieving stable inflation has sparked speculation about potential policy changes.
Our base case is for one-month volatility to drift lower to the 6.25-6.75 region in the coming weeks
Ruchir Sharma, Global head of FX option trading at Nomura International Plc
If the yen remains within its current range, the downward trend in implied volatility for the dollar-yen will likely persist. Some clients have initiated option positions anticipating a gradual upward movement in the currency pair over the next few weeks, as mentioned by London-based Ruchir Sharma. He explained that to offset the risk associated with these trades gaining value, dealers may find themselves compelled to sell dollar-yen volatility, thereby contributing to the ongoing decline in volatility.
An example of such a trading strategy involves acquiring a call option contract with a reverse knock-out condition. Under this arrangement, the call option's value increases with the ascent of the dollar-yen. Still, there is a caveat – if the currency pair reaches the knock-out level before the contract expires, the option becomes worthless.
Currencies Surge as Markets React
In other markets, the influx into higher-yielding currencies contributed to the rise of the Australian and New Zealand dollar. The New Zealand dollar surpassed 62 cents overnight and currently stands at $0.6197, resilient against weak retail sales data, with traders contemplating the possibility of a central bank interest rate hike next week.
The Australian dollar, surpassing its 200-day moving average this week, experienced a 0.1% increase to $0.6563 on Friday, marking a weekly gain of 0.5%—its most significant rise in two months.
The euro is poised for its most substantial gain in two months, driven by a gradual reduction in anticipated interest rate cuts for the year. Market expectations have scaled back from approximately 160 basis points at the end of 2023 to around 90 basis points currently. The euro is currently valued at $1.0836. The U.S. dollar index showed a 0.3% decline for the week, settling at 103.91. Sterling recorded a 0.5% increase for the week, reaching $1.2658.
China's yuan has maintained a stable performance since the Lunar New Year break, showing minimal movement this week at 7.1937 per dollar despite significant cuts to Chinese mortgage rates.