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Foreign Exchange

Yen vulnerable to retail customer liquidation: large downside risks below 76.00

The yen is close to breaching its all-time high of 76.00 against the dollar amid a deadlock in resolving the US government’s debt crisis, which is likely to be further exacerbated by liquidation of currency investments by Japanese retail investors commonly referred to as Mr and Mrs Watanabe.

According to analysts at Deutsche Bank, Japanese retail investors may be forced to unwind loss making short yen positions they are holding as new rules being introduced by Japanese regulators will require retail investors to reduce the amount of leverage they can use for their investments. Currency futures positioning on the Tokyo Financial Exchange show that yen shorts against the dollar are at near record levels. The yen has been strengthening against the dollar from low of 82.03 on May 25. It was trading at 77.10 on July 29.

That raises the prospect of considerable selling pressure next week, should no US debt limit deal be reached. Long positions in EUR/JPY, GBP/JPY and ZAR/JPY could also be vulnerable in any unwinding of JPY shorts, Deutsche adds, though the dollar remains the most vulnerable pairing. They are also high against the euro, the pound and the rand.


 Japanese retail margin net USD long position and USD/JPY
 
 Source: Bloomberg, TFX

On Monday new rules from the Japanese FSA limiting leverage ratios to 25-times principal come into force. Even if most investors have already added extra margin or deleveraged their position accordingly, the move could still further buoy yen sentiment, Deutsche says. The moves represent a regulatory tightening of investor activity in Japan, the world’s largest retail FX market. Last year, maximum leverage ratios stood at 400x principal.

As the yen gets closer to falling through the psychologically significant 76 barrier, the threat of central bank intervention to weaken the currency is growing. In a strategy update released today, Barclays Capital’s Masafumi Yamamoto highlighted Japanese finance minister Yoshihiko Noda’s comments that the government and Bank of Japan could take coordinated action if markets moves were excessive and disorderly.

The stern rhetoric is somewhat surprising, Yamamoto notes, given that Japanese authorities have only taken action since the Asian crisis when a stronger yen caused the Nikkei to decline towards 9,000. Today it closed at 9,833.03, down 0.69%.

BarCap however insists solo BoJ intervention would be difficult. The central bank risks a repeat of its failed solo intervention to weaken the yen last September, when yen selling was subsequently more than offset by the advent of QE2 in the US.

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