Hedge funds were snapping up short-dated options on yen crosses last week to capture volatility after the yen gained in the spot market. The move was triggered by comments by officials in Davos Wednesday that next week's G7 meeting could focus on reversing the yen slide against major currencies. Spillover from lower-than-expected Australian consumer price index figures Wednesday and general concerns about yen weakness also contributed to the yen rally across pairs.
Euro/yen spot fell to JPY156.33 Thursday from JPY158.60 Wednesday, causing one-month implied volatility for EUR/JPY to spike to 7.8% Thursday from 6.3% Wednesday. Sterling/yen dropped to JPY240 from JPY277 and the move was mirrored in U.S. dollar/yen as traders unwound yen-funded carry trades.
London traders reported strong interest in risk reversals and particular interest in one-week yen calls with downside strikes at JPY155 and JPY154 against the euro and JPY234 and JPY233 against the British pound. "The market is entirely focused on the carry trade," said one City trader. "People with carry trades are worried that they are too large and are scared of a big correction."
Despite the rally, however, Steve Barrow, fx strategist at Bear Stearns in London, said the yen remains weak and is likely to fall further if the G7 does not force a more permanent upward correction. "There has been talk before all of the last few G7 meetings about discussing the yen," he said. "But it is not actually included in the communiqué because the U.S. pulls the strings and the U.S. has bigger fish to fry. I don't believe for one minute the U.S. will compromise its efforts on China by going after Japan. So what I think you'll see European pressure and resistance from the U.S., making a non-starter."
