The latest positioning data published last Friday confirm that Japanese investors sold JPY into strength, especially against USD and EUR, in July (Figure 1). In particular, they accumulated net long USD/JPY position of JPY 1.6trn as of the end of July, which is the largest since November 2008 – the beginning of database (Figure 2). We believe that the accumulation of significant net long USD/JPY position by Japanese individuals was one of the factors behind the Japanese government’s decision to unilaterally intervene on 4 August, as stretched positioning meant that there would be less buying on dips by them and, as such, increased risk of disorderly JPY appreciation as they are stopped out. According to higher-frequency TFX data (which is likely to have market share of about 10% in Japan margin FX trades), the net long USD/JPY position had been cut by 28% as of last Friday relative to the pre-intervention level. The fact that the JPY has not appreciated markedly from the intervention levels while investors have been able to cut their JPY-short positions significantly suggests that the intervention was “effective”. This serves to preserve investable capital of Japanese investors and gives them an opportunity to sell JPY when market conditions stabilize (Figure 3).
We have been arguing that the contrarian trading style of Mr. and Mrs. Watanabe has helped to contain the rise in realized vol of JPY-crosses. Indeed, we found that the strength of their contrarian trading style, measured by beta from cross-sectional regression of monthly change in their positions on JPY-cross monthly return, has been well-correlated with average realized vol of JPY-crosses (Figure 4). Note that their contrarian style strengthened since August 2010 – after the Fed began hinting at additional QE and the BoJ became concerned about JPY strength. The potential for accommodative policy by the two central banks increased the likelihood for USD/JPY to range trade in the foreseeable futurem, as well as strengthening the incentives for investors to trade in a contrarian manner.
With external environment still uncertain, Japanese investors remain cautious on adding long USD/JPY positions after the most recent intervention. However, with the Fed likely to keep low rate until mid-2013 (given current fundamentals) and the Japanese government likely to continue in its efforts to smooth any rapid JPY appreciation, we think rangetrading for USDJPY is here to stay. As a result, once risk appetite improves, Japanese investors are likely to resume contrarian trading and help contain the volatility for JPY-crosses.
Figure 1: Japanese individual investors sold JPY against USD and EUR into strength in July …
Figure 2: … and accumulated largest net long USD/JPY position since November 2008
Figure 3: They remain cautious adding long USD/JPY position post-intervention
Figure 4: The level of JPY realized vol and the strength of contrarian trading style by Japanese individuals are well correlated
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