Hedge funds are shorting the yen with $1.1 billion in bearish contracts

Hedge funds are betting against the yen hard this week, dumping more than $1.1 billion into short positions just days before Japan’s Upper House election on Sunday, according to Bloomberg.

Around 12,606 futures and options contracts have been opened against the currency, marking the first net bearish positioning since March.

The focus is on whether Prime Minister Shigeru Ishiba’s Liberal Democratic Party (LDP) can avoid a collapse. The LDP already holds a minority in the lower house.

Now, polls suggest they’re likely to underperform again in the Upper House. If the ruling coalition loses more seats, investors expect chaos on the fiscal front. Economic policy could become harder to manage, and traders are positioning for exactly that.

Traders brace for deeper losses as bond yields rise

Aroop Chatterjee, a currency strategist at Wells Fargo, said, “An LDP loss could open the door to more fiscal spending with the opposition pushing for consumption tax cuts, implying wider fiscal deficits and weighing on long-end” government bonds. His team thinks the yen could drop to 150 per dollar if the opposition takes control. As of Friday, the yen was trading at 148.80.

MUFG strategists gave a similar warning, advising traders to short the yen ahead of the vote. That message has landed. Traders have watched the currency lose nearly 3% in July, after it had rallied 10% in the first half of the year. That rally was tied to weakness in the dollar at the height of Trump’s trade war, but the mood has now flipped.

The situation is being made worse by bond market volatility. Ten-year Japanese government bond yields just touched 1.6%, the highest they’ve been since 2008. The 20- and 30-year bonds are also at levels last seen in 1999. Rising yields are a direct response to fiscal uncertainty, and they’re piling more pressure on the yen.

Jayati Bharadwaj and Alex Loo, both at TD Securities, explained the breakdown like this: “Long yen positioning versus the dollar had been looking stretched and vulnerable. We expect the yen to remain under pressure in the near-term.” They’re not alone.

Options traders flip bias as risk multiplies

Traders in the options market are already preparing for a deeper drop. On July 11, call options on the dollar-yen pair, which profit when the yen weakens, were being bought more than twice as often as puts, based on data from the Chicago Mercantile Exchange’s central limit order book. That ratio shows where the momentum is heading.

Meanwhile, Shigeru’s party is trying to win support with cash handouts, while the opposition wants to cut the sales tax, both policies that could blow up the budget even more. If either of those plans go ahead, deficits will grow. Investors already seem convinced, given the surge in short-term bond yields.

This week, the yen dropped to its lowest level since April, adding to the fear. Short-dated options contracts also turned net negative on the yen versus the dollar, the first time that’s happened in nearly a year. That kind of signal usually means investors are bracing for more pain.

One of the more surprising changes is what’s happening with global reserves. In the first quarter of the year, foreign-exchange managers moved out of the yen and into the Swiss franc in large volumes. That’s unusual, and it shows just how much trust the yen has lost as a safe-haven currency. The switch was driven by Japan’s growing trade deficit and sluggish economic growth.

Some analysts still think a good election outcome could give the yen a small break. Omori from Mizuho Securities said the yen could strengthen to around 144 per dollar if the LDP keeps its majority. But no one’s banking on that.

All eyes are now on the August 1 deadline. If talks between Trump and Japanese officials over tariffs don’t go anywhere by then, it could make things worse. Trade negotiations have dragged on for months with almost no movement. Until something gives, the yen’s outlook is going to stay messy. Traders aren’t waiting to find out. They’ve already decided which way this is going.

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