Hedge funds were taking advantage of low long-dated U.S. dollar/yen implied volatility last week to position for long-term rate hikes from the Bank of Japan. One-year implied volatility was at 8.64% last Thursday, slightly up on 8.58% Monday. The dollar climbed to JPY118.083 Thursday afternoon after Federal Reserve Chairman Ben Bernanke made a more hawkish than expected speech to Congress Wednesday.
Dollar downside options, both puts and calls, were bought as far out as five years. One trader at a German firm said he saw a lot of funds looking to buy options with strikes below JPY100 and with maturities ranging from two to five years, to take the view a shift in rates policy from the BoJ would stir up back-end volatility.
Longer-dated USD/JPY has been driven by carry trades in the last few months, explained Hans Redeker, global head of currency strategy at BNP Paribas in London. Hedge funds have been taking positions funded in yen and so contributing to the uptick in the dollar and suppression of longer-dated implied volatility. Five-year implied volatility has crunched down on the pair to about 8.5% from 10% in November. Volatility has also ground lower over the last week because USD/JPY has returned to an earlier trading range which the market is already familiar with, added Redeker.
Signals from the BoJ rates will rise may trigger an end of the carry trades and will boost implied volatility at the longer end. Hedge funds seem to be buying up longer-dated vol on USD/JPY to ready for carry trades drying up, or even ending completely, added another trader.
