Yen’s 2015 gain confounding currency traders

Add the Bank of Japan to the list of central banks taking currency traders by surprise.

The yen’s 1.9 percent gain versus the dollar this year, second only to the Swiss franc among the Group-of-10 currencies, is a rally strategists didn’t forecast and investors were betting against.

After the yen’s steepest three-year drop on record, markets were used to the idea that the currency was only going down as Japan’s policy makers unveiled ever-greater stimulus to reverse deflation.

Yet since the BOJ expanded its bond-purchase plan to an annual 80 trillion yen ($680 billion) on Oct. 31, speculation for more easing has amounted to nothing as the world’s third-largest economy has shown signs of improvement.

At the same time, central banks from Canada to Norway have shocked with new easing measures, sending their currencies tumbling.

“Estimates all expected the yen to trade much lower this year,” Peter Kinsella, a senior currency strategist at Commerzbank AG, said by phone from London on Thursday. “If you look at what other central banks did, they were easing quite significantly - it’s obviously taken some shine off shorting yen.”

Derivatives traders have changed their view on the yen in the last month, becoming bullish on its prospects. Since the middle of January, they’ve been paying more for options to buy the yen than for those allowing for sales, according to three-month risk-reversal prices.

The premium to buy is now 0.38 percentage point. In December, bearish-yen contracts cost 0.81 percentage point more, the most since 2013.

As well as the BOJ’s decision to refrain from further easing, the yen rally is being supported by signs that Japan’s trade balance is improving after the shortfall widened to a record deficit.

The shortfall shrank to 665 billion yen in December, from 895 billion yen the previous month, as exports increased more than economists forecast. The decline was spurred by the slump in oil since the middle of last year as fuel accounted for a third of Japan’s 86 trillion-yen of imports in 2014.

“Trade deficits and a weak yen have been strongly linked,” Minori Uchida, the head of global-market research at Bank of Tokyo-Mitsubishi UFJ Ltd., said in a Jan. 30 interview. “If the view is increasingly that trade deficits will shrink, it’s highly likely to undermine the weak-yen story.”

Analysts aren’t convinced the rally will continue. The median estimate in a Bloomberg survey of more than 50 strategists is for the yen to weaken 4 percent by mid-year to 122 per dollar, before dropping to 125 by year-end. Both predictions are unchanged since the end of December.

Citigroup Inc., the world’s biggest currency dealer, is even more negative, predicting the yen will drop to 124 per dollar by mid-year and 132 by year-end, in research published last month.

While investors “need to be more wary of the risk of a stronger yen in 2015, particularly in the first half,” the rally is vulnerable to the “longer-term outlook for a stronger dollar,” said Osamu Takashima, a Tokyo-based strategist at the U.S. bank.

The yen was at 117.53 to the dollar on Thursday in New York, up from 119.78 at the end of last year and a 7 1/2-year low of 121.85 on Dec. 8.

The yen’s performance contrasts with those of its peers. The dollar is stronger versus 22 of the 31 most-traded currencies tracked by Bloomberg this year on speculation the Federal Reserve will raise interest rates this year.

“Until we get another policy maneuver from the BOJ, you’re not going to see a massive impetus in the short-yen trade,” said Commerzbank’s Kinsella, whose firm sees a slide to 120 by June 30 with the yen closing the year at 125.

Bloomberg