Hedge funds are rebuilding their short positions on the Japanese yen, preparing for potential further weakness in the currency as Japan approaches a critical election this weekend. The yen has returned to the spotlight after Prime Minister Sanae Takaichi highlighted the benefits of a weaker currency ahead of the February 8th general election. She called the snap election for the lower house to consolidate her leadership, with polls indicating her party is poised to win an independent majority—an outcome that could grant her greater autonomy to implement fiscal stimulus measures, further adding to Japan's already substantial debt burden.

The options market is reflecting this shift. Data from the Depository Trust & Clearing Corporation (DTCC) shows that on Tuesday, trading volume for dollar-yen call options—which profit if the dollar rises against the yen—with a value of $100 million or more, surpassed that of put options of equivalent value. As demand for call options recovers, the premium for hedging against a decline in the dollar-yen pair over the next month, relative to hedging against an increase, has fallen to its lowest level in nearly two weeks.

"The extreme froth in the precious metals market has subsided as conditions stabilize, and hedge funds are increasingly re-engaging in carry trades and Takaichi-themed trades," stated Antony Foster, head of G10 spot trading at Nomura International in London. "With the Japanese election this weekend, markets are again anticipating a higher dollar/yen exchange rate, particularly in the event of a decisive victory for Finance Minister Takaichi."

The yen has been on a downward trajectory since Sanae Takaichi was elected leader of the Liberal Democratic Party in October, falling last month to an 18-month low against the US dollar. A sharp reversal occurred after the New York Fed adjusted the dollar-yen rate on January 23rd, a move later reinforced by comments from US President Trump. However, the yen came under renewed downward pressure after US Treasury Secretary Scott Bessent reaffirmed support for a strong dollar policy and following the nomination of Kevin Warsh as the next Federal Reserve Chair.

Takaichi's recent remarks have further bolstered bullish sentiment for the dollar-yen pair. "Last weekend's comments emphasizing the advantages of a soft yen for exporters seem to have reignited interest in buying dollar-yen," said Mukund Daga, global head of foreign-exchange options at Barclays.

In contrast, asset managers, often referred to as real-money funds, have adopted a more cautious stance during recent volatility, awaiting clearer signals on the currency pair's next direction. "Real money is largely on the sidelines, using options for protection rather than taking outright directional bets on dollar-yen," commented Ivan Stamenovic, head of G10 currency trading for Asia Pacific at Bank of America.

Simultaneously, the minutes from the Bank of Japan's January policy meeting revealed a growing awareness among policymakers of the necessity for timely interest rate hikes, as authorities closely monitor the impact of yen weakness on inflation. According to the minutes, one of the BOJ's nine policy board members said, "Given that tackling price rises is a priority for Japan, the central bank should not take too much time assessing the impact of a policy rate hike but should seize the appropriate moment to proceed with the next step—an interest rate increase."

The minutes suggest that the policy board under Governor Kazuo Ueda could move to raise the benchmark interest rate at a faster pace than widely expected by the market. The consensus expectation is for the BOJ to hike rates approximately every six months, following its last action in December. The yen is clearly a key factor—mentions of "yen weakness" and "foreign exchange" in these minutes doubled compared to the previous policy meeting record.

At the January meeting, the BOJ had sent a relatively hawkish signal, upgrading its inflation outlook more than economists had anticipated, and there was a surprising dissenting vote calling for a second consecutive rate hike. During the post-meeting press conference, Governor Ueda noted the need to scrutinize more carefully the effect of yen depreciation on underlying inflation.

Following the January meeting, institutions including BNP Paribas and SMBC Nikko Securities brought forward their expectations for the next BOJ policy adjustment to April. Even those who maintain that the next move will likely be in June or July are increasingly flagging the rising risk of an earlier policy shift should yen weakness persist.