Since coordinated intervention in August the yen has rallied 7% and surprised many forex traders

Reports of a major break through stop-loss limits at 155 fueled a yen rally to 152

Since hitting a forty-year low in July, the Japanese yen has managed to arrest its long-term decline and is now surprising investors with the speed and scale of its rebound.

In Tuesday trading the dollar briefly fell low below 153 yen, clocking up a six-month high for the Japanese currency, and there are some forex strategists who think it could appreciate further.

Why was the yen (USDJPY) so weak in the first place? Primarily owing to interest-rate differentials between the U.S. and Japan, and Japanese exporters recycling their revenues back into dollar DXY assets, notably U.S. Treasury bonds.

Over a long time frame this encouraged the carry trade, a strategy whereby short positions in the perennially weak, low-yielding yen are used to fund long positions in higher-yielding or riskier assets in other currencies.

Why has the yen suddenly reversed direction? Well, that's a more complicated question to answer. As Mohamed El Erian, former co-chief investment officer at Pimco, commented in a posting on X Tuesday, "The 'what' is clear; the 'why' is elusive." It's not just against the dollar that the yen is making gains: the yen also is strengthening against the pound (GBPJPY), the euro (EURJPY) and the Aussie dollar (AUDJPY).

The turnaround began in August when coordinated intervention by the U.S. Treasury Department and Japan's Ministry of Finance engineered a rebound from the crucial 164 level.

Whereas previous interventions by the Japanese were short-lived and ineffectual, though, this rally has developed momentum.

Robin Brooks, senior economist at the Brookings Institution, thinks the "current strengthening of the yen has all the signs of hidden intervention," meaning that authorities may have intervened more than they publicly have let on. That leads to his view the current yen strength won't last. Brooks wants to see "yield support," or a narrowing of interest-rate differentials between the dollar and the yen to justify a more long-term readjustment higher.

Yield differentials don't work in the yen's favor, argues Robin Brooks

Estimates of the size of the yen carry-trade vary significantly, ranging from the low hundreds of billions of dollars into the trillions, and this sudden yen reversal might have prompted a sudden unwind of that trade, although not quite as violent as the episode in the summer of 2024 which provoked such volatility across global markets.

Another factor persuading carry traders to rethink their exposure may be the imminence of further tightening by the Bank of Japan. Its next policy meeting is Sept. 18, and prediction markets ascribe a 98% probability to a 25 basis point increase to 1%, with some of the signaling coming from Prime Minister Sanae Takaichi and Finance Minister Satsuki Katayama strongly suggesting further tightening in subsequent meetings.

Jim Reid, global head of research at Deutsche Bank, cited recent economic releases as supportive of this view. In his daily market bulletin to clients he noted Japan's real wages grew 2.4% year-over-year in July, ahead of expectations and the most robust since May 2021.Second-quarter GDP was also revised higher from 1.1% to 1.4%. Reid thinks the case for the Bank of Japan hiking is "overwhelming."

Above all else, though, the Japanese yen is undeniably cheap. A report by the Deutsche Bank Research Institute published in July found that the yen's purchasing power had halved since 2012, making Japan an outlier in terms of the cheapness of its currency.

Anatole Kaletsky, co-founder, chairman and chief economist of Gavekal Research, raised the possibility that "the yen's recovery might finally have begun in earnest." He writes that "the yen is now more undervalued than any major currency in modern history." Kaletsky reckons "relative prices, current accounts, fiscal policies and inflationary prospects all imply a much stronger yen.

For U.S. investors, key to assessing the impact of the yen move will be determining whether Japan is bolstering its currency by selling down its holdings of more than $1 trillion of U.S. Treasury bonds BX:TMUBMUSD10Y and repatriating the proceeds. Japanese finance ministry data published last week showed a massive $87 billion reduction in August alone.

In Tuesday trading the yen was off its highs as 154.32.

-Jules Rimmer