The USD/JPY pair has fallen to around 147.70 as the Japanese Yen gains strength. This comes after Japan’s parliamentary elections, where Prime Minister Shigeru Ishiba lost his party’s majority in the upper house. Japan’s markets were closed for Marine Day. Despite the setback, Ishiba intends to keep his position, though there is ongoing political uncertainty after losing the lower house majority in October.

Trade Uncertainties Affecting the Yen

Trade tensions between the US and Japan are putting pressure on the Yen. The US has imposed a 25% tariff on Japanese imports, but Japan hopes for a resolution. The US Dollar has slightly corrected after trade issues with the EU, with the US Dollar Index around 98.15 after hitting a peak of 99.00. In the US, traders are reducing their bets on a dovish Federal Reserve, as June’s CPI report shows rising import prices. The Bank of Japan’s monetary policy impacts the Yen’s value, along with the difference in bond yields between the US and Japan. The Yen is seen as a safe-haven currency, drawing in investors during times of market stress. Its strength often comes from its stability compared to riskier currencies.

Political Risk and Yield Advantage

With the political uncertainty after the elections and Mr. Kishida’s low approval ratings, we expect continued volatility for the Yen. This instability, combined with Japan’s reputation as a safe-haven asset, suggests traders should prepare for sharp declines in the USD/JPY pair. Buying USD/JPY put options might be a good strategy to hedge against or profit from sudden Yen strength. However, the fundamental situation is largely influenced by the significant interest rate difference between the US and Japan. The US 10-year Treasury yield is around 4.2%, while Japan’s 10-year government bond yield is below 1.0%. This strong carry trade favors the dollar, making it risky to short the USD/JPY pair without a clear reason. It’s also important to note the recent interventions by Japanese authorities. The Ministry of Finance spent a record 9.8 trillion yen in April and May 2024 to support its currency when the pair exceeded the 160 mark. This action may create a perceived ceiling, making traders cautious about holding long positions at high levels. These conflicting factors—political risk versus yield advantage—suggest a time of high implied volatility, recently around 9-10% for one-month options. We see a trading opportunity in this volatility through strategies like long straddles or strangles, allowing traders to profit from significant price swings in either direction without needing to predict the specific cause. For those who have a directional bias, we believe option spreads provide a defined-risk approach. A trader who is cautiously bullish on USD/JPY due to the rate difference could buy a call spread. This strategy could yield profits from a modest rise in the pair while limiting losses if government actions or political news trigger a sudden drop. Create your live VT Markets account and start trading now.

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