The yen's surge may come to a sudden halt next Wednesday as the Bank of Japan's decision becomes a key turning point

According to the Wisdom Financial APP, in recent weeks, investors have been betting on the Japanese Yen, expecting that changes in interest rates will have a positive impact on the Japanese economy. However, they will face a crucial moment as early as next Wednesday, when the policy decision of the Bank of Japan will have a significant impact on the Yen's trend.

Since July 11th, the Yen to US Dollar exchange rate has risen by about 5%. Data shows that the Yen to US Dollar exchange rate broke above 153 for the first time since May 6th, rising for the fourth consecutive trading day, outperforming all other currencies in the G10. However, after the stronger-than-expected economic growth data released in the US overnight, the Yen quickly gave back its gains, showing the fragility of its uptrend. Forward market data shows that there is a 38% possibility of the Bank of Japan raising interest rates by 15 basis points at the end of the policy meeting on July 31st, reflecting the market's cautious expectations towards the central bank.

A survey shows that only 30% of BOJ watchers predict a rate hike, although over 90% believe there is a risk of a rate hike. This uncertainty has made the Yen long positions particularly vulnerable, especially if the Bank of Japan fails to meet the market's expectations of a significant reduction in bond purchases, or if the actions of the Federal Reserve later in the day weaken the market's expectations of rate cuts in the US in the coming months.

"This is a crazy Yen rebound," said Nick Twidale of ATFX Global Markets, who has 25 years of experience in Yen trading. "If the Bank of Japan fails to play its role in tightening policy, it could disappoint the market."

Twidale warned that if the Bank of Japan's measures fail to meet market expectations, arbitrage trades that previously suppressed the Yen exchange rate could become active again. Meanwhile, other market participants, from BlackRock to former central bank officials, predict that the Bank of Japan will maintain interest rates unchanged for a longer period.

Unbalanced economic data has also added complexity to the Bank of Japan's decision-making. While key indicators measuring the strength of Japan's service sector rebounded in July, indicators of factory activity showed contraction. In addition, weak consumer spending may make the Bank of Japan's decision next week even more difficult.

"If the Bank of Japan takes no action, the USD/JPY exchange rate may soar again," said Amir Anvarzadeh, a strategist at Asymmetric Advisors with over 30 years of experience tracking the Japanese market.

On Friday, the Yen exchange rate fluctuated slightly. At 10:15 am Tokyo time, the Yen to US Dollar exchange rate remained stable at 153.96, with consumer prices rising for the third consecutive month according to the inflation data released earlier. The Japanese Ministry of Internal Affairs reported on Friday that consumer prices in Tokyo, excluding fresh food, rose by 2.2%, higher than June's 2.1%, in line with general expectations. Energy prices drove the increase, with electricity prices rising by 19.7% year-on-year. The increase in processed food prices slightly slowed down. As the accommodation subsidy was gradually phased out a year ago, the growth rate of hotel prices also slowed down

Figure 1

Nathan Swami, Managing Director of Foreign Exchange Trading at Citigroup Group in Singapore, believes that after the significant fluctuations in the Japanese Yen this week, the demand for bullish Yen options may increase. However, he pointed out that it is still too early to determine whether this indicates a long-term shift in investor sentiment, and it is more likely a strategic shift in short-term positions or hedging activities.

Other traders have indicated that due to uncertainty about how much the Yen will appreciate before the Bank of Japan policy meeting next week, some hedge funds are still adopting a wait-and-see attitude. Rodrigo Catril of National Australia Bank Limited predicts that if the Bank of Japan fails to meet market expectations, the Yen to US Dollar exchange rate could fall to the 158 level.

Nevertheless, even if the Bank of Japan does tighten its policy next Wednesday, the Yen may still be favored by arbitrage trading. After the rate hike, the implied yield of the Yen will still be about 90 basis points lower than the Swiss Franc, which is used as a funding currency alternative for arbitrage trading.

Figure 2

The risk of US interest rates should not be overlooked either. If the likelihood of a rate cut by the Federal Reserve diminishes, the Japanese currency may face another impact. Charu Chanana, Head of Currency Strategy at Saxo Capital Markets, stated, "If the Federal Reserve does not hint at a rate cut in September and US data begins to strengthen again, the Yen may test 160."