Adam Cole, head of FX strategy at RBC, says heavy coupon receipts and thin liquidity leave the downside in USDJPY particularly vulnerable in August.
He believes that after the range trade in May, June and July, the medium-term trend for JPY strength is likely to reassert itself.
For the past decade, USDJPY has on average risen in the first six months of each year and fallen in each of the months of the second half, after normalizing for the downtrend in USDJPY for the whole period.
More formally, Cole says, USDJPY weakness – and weakness in several JPY crosses – is statistically significant in August and October, a rare occurrence for G10 currency pairs.
USDJPY tends to sell off in the second half of the calendar year
Source: RBC, Bloomberg
A number of factors underlie the tendency for JPY appreciation, even if it is too soon for half-year repatriation from corporates, which tends to take place in late September.
Rather than that, Cole says it is the income stream on Japan’s huge stock of overseas assets that explains the phenomenon.
Coupon receipts rise sharply in August
Source: RBC, MoF
August has the second highest concentration of coupon payments after February. This concentration, says Cole, reflects the dominance of US Treasury holdings in Japanese overseas investment portfolios.
“This clustering of coupon payments, a large proportion of which is no doubt repatriated, has potentially greater-than-normal significance in August, simply because FX markets are so thin,” he says.
Indeed, data from Icap and CLS show FX turnover in August is the second lowest of the year after December.
FX liquiidty thins out in August
Source: RBC, Icap, CLS
“Whilst not a full explanation, this concentration of repatriation flow in one of the quietest periods for FX activity goes some way toward explaining why JPY has a persistent tendency to rally in August,” says Cole.
He is positioned for USDJPY to be unable to sustain rally, and is short USDJPY calls with an August 27 expiry and Y82.00 strike.
“Given the evidence that outright downside dominates in August in particular, we will take any bounce in USDJPY in the remaining weeks of July as an opportunity to close this position and roll into a short spot position,” says Cole.
The main risk to the trade is another bout of large-scale intervention from the authorities in Tokyo.
“But with USDJPY still 160 points above the June low and more than 300 points from the year’s low, this risk is not sufficiently elevated to keep us out of the trade.”