The expectation of the Federal Reserve cutting interest rates has decreased, and the strengthening of the US dollar has suppressed the Japanese yen

The latest US inflation data exceeds market expectations, indicating that inflation may still be sticky. This data has led the market to readjust its expectations for the Federal Reserve's monetary policy. Previously, the market had expected the Federal Reserve to cut interest rates multiple times in 2024, but the current bet has been reduced to only one rate cut for the whole year.

The sustained high inflation in the United States has reduced market expectations for the Federal Reserve to cut interest rates, and this background is favorable for the US dollar. Analysts at Barclays Plc pointed out that the strength of the US dollar directly weakens the attractiveness of the Japanese yen, prompting investors to adjust their options trading on the yen.

In addition, the rise in US bond yields also puts pressure on the Japanese yen. Due to the still large interest rate differential between Japan and the United States, capital flows tend towards higher yielding US dollar assets, while the Japanese yen is more fragile in this situation.

Geopolitical easing weakens yen's safe haven demand

In addition to the change of the Federal Reserve's policy, the market's optimistic expectation of the possible end of the Russia-Ukraine conflict further weakened the safe haven demand of the yen. Optimistic expectations about a ceasefire agreement between Russia and Ukraine are weakening market demand for safe haven assets, "said Niraj Athavel, Asia Pacific Sales Director at JPMorgan Chase.

The recent trend in the options market indicates that investors are withdrawing from their previous bets on the appreciation of the Japanese yen, especially with the EUR/JPY and AUD/JPY options trading showing a bearish trend towards the yen.

Market data shows that in the option trading of EUR/JPY, the trading volume of call options (call EUR) is five times that of put options (put EUR), indicating that the market's expectation of yen depreciation is increasing. The option trading of Australian dollar against Japanese yen also shows a similar trend, with the trading volume of bullish Australian dollar being twice that of bullish Japanese yen.

Trend changes in the Japanese yen options market

The trend of the options market often reflects investors' expectations for future trends. Recently, there have been significant changes in the structure of the Japanese yen options market, indicating that investors are adjusting their bets on the yen.

1. Increased trading of put yen options

The data shows that there has been a significant decrease in bullish bets on the Japanese yen in the euro yen and Australian dollar yen options markets compared to last week. Previously, the market's expectation that the Bank of Japan may adjust its policies had pushed the yen to strengthen in the short term, but this trend has now reversed.

The premium for call options on the Japanese yen has been decreasing for three consecutive days, indicating that market confidence in the appreciation of the yen is weakening, "said Saurabh Tandon, Global Head of Foreign Exchange Options at Standard Chartered Bank. Recent market trends have prompted investors to abandon their previous long positions in the yen.

2. Withdrawal of funds from long positions in the Japanese yen

According to data from JPMorgan, investors are closing their long positions in the Japanese yen, especially the short positions in the USD/JPY and EUR/JPY exchange rates, which have been significantly reduced.

Tandon pointed out that the significant decrease in short trading of the US dollar against the Japanese yen and the cross session of the Japanese yen indicates that market sentiment has shifted from a bullish stance towards the yen to a more cautious attitude. In the short term, investor demand for the yen may continue to decline.

Domestic institutions in Japan expect further weakening of the yen

Not only the international market, but also domestic financial institutions in Japan are more pessimistic about the future trend of the yen. Fukuoka Financial Group Inc. predicts that the US dollar may return to the level of 157 against the Japanese yen, which was last seen in mid January this year.

Tohru Sasaki, a strategist at the institution, said, "Investors have no choice but to close out long positions in the Japanese yen because the US dollar continues to strengthen and the cost of holding long positions in the yen is too high

Despite the increasing bearish sentiment towards the Japanese yen in the market, there has not been a large-scale sell-off in the spot market for the yen at present. As of February 13th, the US dollar against the Japanese yen was trading around 154.28, still at the low level of the week.