Abe smiles as traders start to shun yen

Derivatives traders are turning against the yen, and that’s how Japanese Prime Minister Shinzo Abe wants it.

The price of options show traders are closer to turning bearish on the currency than at any time since November, implying they see no reason for the yen to extend its 3 percent advance against the dollar this year.

“There’s scope for momentum to shift,” said Derek Halpenny, head of global markets research at Bank of Tokyo-Mitsubishi in London. The yen will weaken “if we get the drivers falling into place.” The currency will tumble more than 5 percent to 108 per dollar by year end, he forecasts, from 102.35 yesterday in New York.

Abe is counting on a falling yen to help eradicate deflation and support exporters as his government unveils the latest plans to revive growth as part of the so-called third arrow in his efforts to revive the world’s third-largest economy. The first two arrows consisted of fiscal stimulus and record monetary easing, while the last involves structural reforms such as lower corporate taxes.

While a sustained drop in the exchange rate would be a vindication of policies Abe has pursued since coming to power 18 months ago, a weaker yen has eluded him this year as investors sought the currency as a haven from the crisis in Ukraine and a slowdown in global emerging markets. The yen traded at 102.25 per dollar as of 1:08 p.m. in Tokyo, rebounding from last year’s 18 percent slide, its sharpest drop since 1979.

That may soon change. The premium for one-month risk-reversal options granting the right to sell the dollar against the yen over those allowing for purchases shrank to 0.04 percentage point on June 5, down from as much as 1.61 in February, data compiled by Bloomberg show. The gap was 0.15 percentage points yesterday.

“The options market is again positioning for high strikes for the dollar versus the yen,” said Olivier Korber, a derivatives strategist at Societe Generale in Paris. He was referring to contracts that bet the dollar will rise versus the yen. Even so, a switch in the market’s positioning to yen bearishness “is very unlikely if the spot rate doesn’t accelerate above 104,” he said.

The yen is the third-best performer in a basket of 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes this year, climbing 3 percent. That’s exceeded only by the Australian and New Zealand dollars.

It’s also being supported by speculation that the Bank of Japan won’t expand its 70 trillion yen ($684 billion) annual bond-buying program at this week’s policy meeting.

There are signs that the main aim of Japan’s policy - raising prices in a country that suffered 15 years of deflation into the 1990s - is working. Consumer prices excluding fresh food increased 3.2 percent in April from a year earlier, the most since 1991. A weaker yen would give another leg up to consumer prices by making imports more expensive.

Graham Davidson, a foreign-exchange trader in London at National Australia Bank, said he’s using options to bet the yen will fall. He predicts it will trade from 105 to 110 per dollar in the second half of the year, in part as rising bond yields in the United States attract international investment.

Yields on two-year Treasury notes are about 35 basis points, or 0.35 percentage point, higher than those for similar maturity Japanese government bonds. That’s above the average of about 22 basis points since the start of last year.

Bloomberg