The yen has room to weaken more before Japanese officials step in to support the currency, options suggest.
Traders are comfortable pricing yen weakness all the way to 165 per dollar — a drop of about 1.6% from the current level, which is already near the weakest in four decades.
A combination of global and local factors are weighing on the currency. In late April, the Japanese government intervened, spending almost $74 billion to prop up the yen, spurring a rebound that proved short-lived. Officials have since issued verbal warnings that they stand ready to act again if needed.
Here are some of the options metrics hinting that the government may tolerate more weakness, to a point:
One-week risk reversals, a gauge of short-dated demand for protection against yen gains or losses, show yen calls are trading at a 176 basis-point premium to puts. That suggests the market continues to acknowledge there’s a risk of the currency rallying as long as interventions could happen, though the premium is far below the extremes seen in May.
Implied volatility tells a similar story. One-week hedging costs for the dollar-yen pair, which protect against swings in either direction, are less than half their levels after the April intervention and close to a four-year low reached in late May, when the yen was roughly 1.5% stronger. That could mean traders don’t see a high probability of intervention in the coming days.
The options expiry profile also points to a market that’s prepared for more yen weakness. Over the next month, sizable expiries are clustered in the 162-164 area, suggesting traders see a move to the 165 handle as providing a possible trigger for the central bank to step in.
The 165 level is popping up elsewhere: Goldman Sachs strategists recently raised their one-year dollar-yen forecast to 165 from 155, citing persistent upward pressure unless the U.S. growth outlook deteriorates sharply or the Bank of Japan turns more aggressive.
The gap between U.S. and Japanese interest rates — which encourages investors to sell yen to invest in higher-yielding U.S. assets — is keeping pressure on the currency.
The U.S.-Japan two-year yield spread has widened since early May and the dollar-yen pair is following. That message is echoed in longer-dated options: one-year risk reversals, which filter out short-term intervention noise, have turned modestly dollar-bullish for the first time since late 2022.
Even the approach of Japan’s next public holidays, which some strategists have flagged as a possible window for interventions, aren’t stirring imminent bets on yen strength. Short-dated options metrics are still well below the extremes seen around earlier periods when intervention speculation was elevated.