USDJPY and Gamma Trading (29th July 2024)
Highlights:
- Owning gamma exposure in USDJPY into a frenetic week of data and Central Bank meetings provides attractive risk reward and protection against risk-off.
In our piece in February (Turning Japanese, Feb 2024) we discussed how carry trades in currencies have a predisposition to trade an “escalator / liftshaft” pattern. The Japanese Yen, as the principal funding currency, is particularly vulnerable to violent reversals to what has been a remarkably steady and successful carry trade.
In the last couple of weeks, as analysts started to consider the possibility of a BoJ rate hike at their meeting on 31st July, JPY crosses exhibited a bout of significant strength. USDJPY fell around 10 big figures from ~162 to 152. Is that enough to have cleared the decks?
Simply put, it is not possible to clear out two years of accumulated positions in a couple of weeks. The fact that CFTC commitment of trader positioning was showing JPY shorts at their most extended since 2007 (pre GFC) before last week’s sharpish position reduction, suggests this is merely a shot across the bows, so far. Japanese retail traders (Mrs Watanabe) have slowed accumulation to a stand still but wholesale flight is far from evident.
We note that there has been a plethora of articles arguing that this is a dip buying opportunity and that carry is still highly attractive as an investment approach, which is a recognisable behavioural response when people are already heavily invested in the primary trend. They are correct to point out that carry to volatility remains in good shape, but we think this is classic complacency.
Might it be different this time? We have been particularly intrigued by the fact that this episode has coincided with a wave of angst washing through tech stocks and with the Nasdaq under significant pressure. Risk-off episodes typically affect carry trades too.
What about catalysts?
This week (starting Monday 29th July) is particularly intense in terms of potential endogenous disruptors, not to mention the geo-political tension around Gaza and the Lebanon which depressingly escalated again over the weekend.
Tuesday 30th July:
Microsoft earnings.
Wednesday 31st July:
BoJ Meeting. Risk of a rate hike. (Market expectations are 50:50 for 15 bpts at the time of writing)
FOMC. No cut expected but meeting is definitely live. The Press Conference will be keenly observed.
Meta earnings.
Thurs 1st August
BOE MPC Meeting: rate cute widely expected.
US ISM
Amazon & Apple earnings.
Friday 2nd August:
Non-Farm Payrolls and Unemployment. Forecasts are anodyne (~+180k and unchanged at 4.1%). Room for disappointment?
Trade:
We like owning gamma in USDJPY into this week’s string of announcements. There is little or no fear priced into the currency options markets, although USDJPY implied volatility did rise a little and risk reversals shifted to skew for downside protection somewhat last week.
If you do the trade suggested, use the gamma trading opportunities offered by any outsize surprises in the data releases. Obviously, the humdinger would be a rate hike by the BoJ and a cut a few hours later by the Fed. If this were compounded by tech earnings disappointing and AI capex guidance sagging…then game on. Even without those outliers, the likelihood of earning more than your theta back is good and you open up a right tail in your risk profile if we go full-scale risk-off.