Mrs Watanabe has amassed a large short yen position

By Marc Chandler

Between the looming US debt ceiling and the European debt crisis, the Japanese yen has been largely sidelined. Over the past three sessions, for example, the dollar has been confined to a JPY78.80-JPY79.30 range. The implied 3-month volatility is hovering near 10%, a level that it is has rarely traded below since the financial crisis began around 4 years ago.

Nevertheless, something interesting is being played out. Margin traders–the famed Mrs Watanabe– at the Tokyo Futures Exchange–have amassed a large short yen position. There are about 900k short yen contracts as of today and about 364k are short yen against the dollar. This is the largest short yen long dollar positions since 2006.

In contrast, the net speculative position at the IMM has long yen and growing longer. As of last Tuesday, the net speculative position stood at 28.2k contracts, a doubling of the long positions over the past week.

To be sure the contracts are dramatically different sizes. The Tokyo Futures contracts are $10k, while the IMM contracts are JPY12.5 mln ($158k). That means that the short yen long dollar position at the Tokyo Futures Exchange is worth about $3.6 bln,while the IMM position is valued at roughly $4.4 bln.

It is also noteworthy that short yen contracts at the TFE are a little above 900k, making the dollar share about 40%. After the dollar, the long euro and long Australian dollar positions stand out as well.

The logic and rationale of the positions are not necessarily knowable, but the IMM positions would seem be consistent with low level of fear of BOJ intervention, while the TFE would seem to be positioned to benefit from intervention. Of course there are other considerations For example, in the past week the 10-year interest rate differential have moved 12 bp in the US favor. However over the past month, the spread has widened only 6 bp.

Perhaps the 10-year spread is not the best proxy for "carry trades" as the purchases of US bonds may be funding by short-term yen. Maybe the better comparison is the spread between shorter dated yen like TIBOR vs the US 10 year. But TIBOR is fairly steady so it is just the change in the US interest rate that is key and the change in the spread is marginal at best. The carry trade rationale does not seem compelling.

It is not clear which side–TFE or IMM–are going to win out or capitulate first. Given the low volatility and the US and European debt tensions, we continue to suspect that the risk of BOJ intervention is low. At the same time, as the euro zone economy appears to be losing momentum and the US economy is disappointing, the Japanese economy looks poised stage a stronger recovery in the coming months.

We note that the Nikkei is the best performing G7 equity market over the past month. Foreign investors had been substantial buyers of Japanese share in the first part of the year (~$40 bln through April), repatriated some money in Q2 but in recent weeks have returned to the buy side again.