Nervous hedge fund traders scooped up short-dated options across yen pairs last week ahead of a Bank of Japan meeting Wednesday. The market is signaling that a rate hike might be a reasonable option for the central bank, even though the Group of Seven industrialized nations meeting passed as a non-event over the weekend.
There has been virtually no interest in long-dated options and investors were primarily buying one-week U.S. dollar/yen calls with downside strikes from JPY120 and down. Spot was hovering around JPY120 late last Wednesday.
"People continue to position to cover event risks. Everyone still wants to be long downside here," said a trader in New York. "There was no major shift in dollar-yen spot sentiment after the G7 meeting but there was a temporary relief sell-off in volatility." Positioning prior to the G7 meeting had caused a spike in one-week implied volatility two weeks ago up to around 9%. One-week implied vols had dropped to 8.1% last Wednesday afternoon.
Even if the Bank of Japan raises rates at their policy meeting, interest-rate differentials are still large enough to make the carry trade attractive in the near term, traders noted.
"By cautioning over one-way bets, while failing to call attention specifically to the yen's undervaluation, the G7 gave markets little reason to reverse carry trades," said Naomi Fink, strategist at BNP Paribas in New York. "Investors' unwillingness to push the yen to fresh lows on most crosses might very well indicate that the carry trade has reached a point of saturation, and that investor willingness to assume new risk will decline, not increase, from here," she added.