FX Flash – Yen set to strengthen versus the euro

by: Georgette Boele

  • The risk of a sharp appreciation of the yen is increasing substantially…
  • …because of a deterioration in investor sentiment…
  • …and the focus on the French elections

The risk of a sharp appreciation of the yen is increasing substantially. First, the FOMC minutes signaled that the start the process of reducing the Fed’s balance sheet is on the cards for later this year. This led to a deterioration in investor sentiment on financial markets. The yen is a global safe haven currency, which rallies if investor sentiment deteriorates. Demand for the yen has clearly increased. Moreover, currency markets have set their focus on the French Presidential elections. The first and second rounds of these elections now fall within the 1-month tenor in the currency options markets. Investors have decided to hedge for potential euro downside in the case the result of the French Presidential elections is not favourable for the eurozone. As a result, the costs to hedge against a lower euro versus US dollar, sterling and Japanese yen have risen substantially. This is because option volatility moved up and demand for euro puts has increased. The 1-month preference for euro puts versus the US dollar, sterling and Japanese yen is approaching crisis levels (but liquidity is thin), while volatility has further room to increase. What does this mean? In the coming weeks the downward pressure on the euro versus US dollar, yen and sterling will likely increase. We expect EUR/JPY to be the most vulnerable. EUR/USD could be relatively stable as both the US dollar and the euro are out of favour. Sterling could benefit from euro weakness if the risks related to Brexit do not escalate further.