The yen is once again being hunted! Short positions hit a two-year high as traders' bets on interest rate hikes and interventions prove futile.

Investors have built up the largest short position on the Japanese yen in nearly two years, betting that neither a rate hike by the Bank of Japan nor intervention by Japanese authorities can rescue the weak yen. This short position is also the largest since the last time Japanese authorities intervened in the foreign exchange market in 2024, laying the groundwork for testing the resolve of Japanese authorities to defend the yen and counter speculative activities. According to data from HSBC, Japanese retail forex traders, nicknamed "Mrs. Watanabe," currently hold the largest non-dollar cross yen short position since February 2020. Investors are reportedly selling yen against the euro, Swiss franc, pound, and Australian dollar. Currently, the yen is at its weakest level against the euro since the euro's inception, at a historical low against the Swiss franc, at a new low against the pound since the global financial crisis, and at its weakest level against the Australian dollar in 30 years. In terms of the yen against the dollar, although the risk of direct intervention has temporarily halted the yen's decline against the dollar over the past five years, the trend of the yen against the dollar over the past year has ignored the significant narrowing of the US-Japan interest rate differential. In the past seven weeks, the dollar-yen exchange rate has remained stable below 160, which is considered a "red line" for Japanese authorities to intervene. As of the time of writing, the dollar-yen exchange rate is at 159.79. The Bank of Japan kept interest rates unchanged on Tuesday, but three out of nine members of its policy board opposed keeping rates unchanged and proposed a rate hike, indicating concerns among policymakers about inflationary pressures stemming from the Middle East conflict. The central bank also significantly raised its inflation expectations, emphasizing the need to be wary of the risk of excessive inflation, indicating a high likelihood of a rate hike in the coming months. However, following the announcement of the rate decision, despite signaling readiness to raise rates to address broader inflation, Bank of Japan Governor Kikuo Iwata did not give a clear signal on when the rate hike would occur, leading to a lack of effective boost for the yen. Hirofumi Suzuki, Chief FX Strategist at Mitsui Sumitomo Banking Corporation, said, "Iwata's stance is not particularly hawkish. While he acknowledges the possibility of a rate hike in the June meeting or subsequent meetings, he seems to emphasize that any rate hike decision will depend on the specific circumstances at that time. This is likely to be seen as pressure for yen depreciation." One of the pressures facing the yen is the persistently negative real interest rates. With an overall CPI increase of 1.5%, Japan's real interest rates remain negative when inflation is factored in. Sho Suzuki, a market analyst at Matsui Securities, said, "I expect the situation of negative real interest rates to remain unchanged, so I believe there is a high probability that the yen will remain weak." The continued weakness of the yen has also increased the attractiveness of shorting the yen. Cameron Systermans, Head of Asia Multi-Asset at Mercer Investments Japan, said, "All interest rate models show that the yen should be much stronger than its current levels." He pointed out that the fair value of one-year period should be lower than 1 dollar to 150 yen. He added, "Short positions on the yen can earn carry returns, and holding such positions itself generates returns, so many people are happy to continue holding them." Cameron Systermans also warned that market momentum could suddenly reverse. Foreign exchange intervention remains one of the biggest risks facing the yen weakening. Officials including Japanese Finance Minister Katsuyuki Kawanami and Japan's top currency official, Junzaburo Mura, have repeatedly warned the market of possible intervention in the currency markets. The New York Fed's interest rate inspection in January also "hit" many traders trying to short the yen. The persistent risk of intervention has raised concerns in the market that the yen could suddenly rebound as it did in 2022 and 2024, leading to rapid unwinding of a large amount of yen-based arbitrage trades and potentially impacting global markets including US stocks and bonds. However, as Japanese authorities have continued to issue verbal warnings without taking action, the market's sensitivity to forex intervention has decreased. With a significant gap still existing between the Bank of Japan's interest rates and those of other major central banks, it is unclear whether Japanese authorities' intervention measures can achieve effects similar to those in 2022 and 2024. Junya Tanase, Chief Japan FX Strategist at JPMorgan Tokyo and former special officer for foreign exchange reserves management at the Japanese Ministry of Finance, noted that phrases like "decisive action" that are seen as precursors to intervention were only used in September 2022 and even after actual intervention, indicating that there are no rules or manuals. Certainly, some fundamental indicators (such as interest rate differentials) show that the yen has room to rebound, and many investors are betting that it will rise. Vincent Deluard, Head of Global Macro Strategy at StoneX, wrote earlier this month in a report, "The yen is severely undervalued. If the US and Iran reach an agreement and permanently reopen the Strait of Hormuz, the yen will rise." However, with no agreement reached, Japan not eager to raise rates, and concerns over high and rising government fiscal expenditures, data from the US Commodity Futures Trading Commission (CFTC) shows that yen short bets have continued to climb since February, reaching the highest level since July 2024. Olivier d'Assier, Head of Investment Decision Research for Asia at consultancy SimCorp, said, "Both the Bank of Japan and the government are avoiding the fiscal cliff they face, and any level of intervention is unlikely to be effective." "For investors, this means you have to offer higher returns to keep them holding long-term bonds. If you don't offer higher returns, they will turn elsewhere - which means they will sell bonds and sell yen." Overall, from the perspectives of policy success, international cooperation, and market structure, the "effective space" and "trigger threshold" for Japanese authorities to intervene in the forex market are significantly more limited now than in the rounds of intervention in 2022 and 2024. If the yen's decline becomes faster, more erratic, and clearly diverges from orderly fluctuations, the Japanese Ministry of Finance may still step in, especially around 1 dollar to 160 yen or weaker. However, in terms of lasting effects, what could truly change the yen's weakening trend is likely to be a calming of the situation in the Middle East, a drop in oil prices, or an earlier-than-expected rate hike by the Bank of Japan to narrow the US-Japan interest rate differential.