A confluence of factors -- a new government stepping in with a hands-off view on currency intervention and a long holiday weekend in Japan -- is leaving the dollar prone to a deeper drop, possibly even beyond the 14-year low of ¥87.10 hit earlier in the year.
"A move below ¥87.20 runs the risk of a sharply accelerating move," said Gerrard Katz, head of North Asia foreign exchange trading at Standard Chartered in Hong Kong. He said some players were not as exposed at these levels as last year.
The yen pushed higher on Wednesday after incoming Finance Minister Hirohisa Fujii made clear he was not prepared to step into the market, saying he is opposed to intervention unless the market is volatile and he sees the current rise as rapid.
One senior FX options dealer in Tokyo is even staying close to town during next week's five-day break through next Wednesday, fretting that there could be a disorderly dollar fall below ¥90 because so many market players are not expecting such a move.
The steady climb against the dollar and other currencies has kept gauges of volatility subdued and made hedge funds and other players reluctant to buy implied volatility, especially before the long weekend and an upcoming stretch lacking market-moving events.
Speculators pushing yenImplied volatility shows how the options market is bracing for a currency pair to move over a given time frame, with realized volatility an important factor in the pricing.
A consensus has formed that even if the dollar falls below ¥90, the U.S. currency is unlikely to slide very far. Thus market players who normally seek protection in the options market are not buying yen calls or taking other, similar positions.
Over the weekend, Japanese importers and other companies that are typically buyers of the dollar for trade settlements are going to be absent even as speculators might try to push the yen as far as they can.
On the other hand, exporters that are not sufficiently hedged against a stronger yen may be forced to buy into a dollar/yen slide, exacerbating the move.
One senior yen trader at a European bank in Hong Kong said: "You can hear the exporters screaming from here."
The latest Bank of Japan tankan survey and individual company reports show that many of the biggest exporters had planned for a dollar/yen rate near ¥95 for the business year to March, meaning that current levels are likely testing their pain threshold.
0:00/1:20Signs of growth for Japan"An unexpectedly sharp slide in dollar/yen, breaking below a significant level, could trigger panicky dollar selling from investors and corporates who had been delaying their dollar selling, and such selling may snowball," said a senior options trader for a big Japanese bank in Tokyo.
"It is only a risk scenario, but we may have to come in even during the holidays if something drastic happens. People don't want to be called in and have to drive long hours returning to Tokyo, as happened to some people after the Lehman collapse. It is a better idea to stay in Tokyo."
Intervention hard to justifyImplied volatility on one-month dollar/yen options were quoted at 13.9% late in Tokyo on Wednesday as the dollar fell to ¥90.12, below the ¥90.18 hit on Monday -- its weakest level since January when it fell down to ¥87.10 on trading platform EBS.
That level of implied volatility, or vol, is well within a rough range of 12.5% and 15.5% that has held in place for the last four months because the spot market moves lately have been so subdued.
Indeed, when looking at how much dollar/yen has moved on a rolling one-month basis -- its realized volatility -- it is only 8.5% and fell as low as 7.3% last week, what was the lowest since early 2008.
The low realized volatility is keeping a lid on implied vols and also means it would be hard for officials to justify intervening based on volatility, which is commonly cited by Group of Seven powers and others in justifying intervention.
Traders said a hefty barrier option, which is activated once the underlying reaches a certain level, is located at ¥90 and due to expire on Sept. 28. The option, which is believed to be held by a Japanese corporate for hedging needs around the fiscal half-year end, may help keep dollar/yen around that level in coming days.
Highlighting how market players are not positioned for a further dollar fall against the yen, benchmark one-month risk reversals are only favoring options to buy the yen by 2.2%, according to broker GFI.
That level is up slightly from August but is still showing very little positioning after dollar/yen risk reversals, which show how the options market is leaning in different currency pairs, reached 3.5% in July when the dollar started breaking down against the yen.
Those risk reversals reached historical extremes at 11.5% last October during the yen's surge as huge carry trades and related derivatives blew up during the post-Lehman market plunge -- levels that option dealers in Tokyo had never thought they would see.
Dealers are worried that more forced derivative desk hedging to buy the yen could emerge on a drop below ¥87.10 and around levels such as ¥85.
"The timing is not good for Tokyo players. We cannot take risks before half fiscal year-end," said a proprietary trader at a Japanese bank in Tokyo.
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