The Yen Reversal Isn't Over Yet

This summer, the Japanese yen went from being an often forgotten currency to making front-page news.

In a few short days, the so-called "yen-carry trade" blew up.

You see, hedge funds had been borrowing in yen for years to buy U.S. stocks. These hedge funds were able to juice their returns because the yen was cheap after a long downturn.

But in August, the yen soared in value... And it shook the global financial system for a moment.

Things soon calmed down – even though the yen continued to rise. But in recent months, the trend has changed.

After a burst of bullish sentiment, the yen rally has stalled. It's falling again. And we likely won't see that reverse until this extreme sentiment turns over.

Currencies should be boring. If your local currency is moving fast in either direction, it's not doing its job as a stable source of value.

That has been a big problem for the yen. The currency has absolutely crashed in recent years – falling 36% from the 2021 high through the low this summer.

It quickly rallied 15% in the wake of the yen-carry explosion. But that reversal also caused a massive rise in bets in the futures market. We can see it clearly by looking at the Commitment of Traders ("COT") report for the yen...

This weekly report shows us what futures traders are doing with their money. And when these folks all agree on an outcome, the opposite tends to occur.

The COT report was at its lowest reading ever before the recent blowup. But afterward, it soared to a multiyear high. Take a look...

Futures traders hated the yen. But then, the currency soared... And traders swung from extremely bearish to extremely bullish.

This isn't a good sign for a sustained yen rally. We've only seen sentiment this bullish a few times over the past 15 years. And in each case, the yen lost value in the following weeks. Take a look...

Futures traders loved the yen in 2012... just before a multiyear decline for the currency. It happened again in 2016... just as the currency began a multimonth slide. Finally, the COT reading was hugely bullish in 2021... and the yen went on to collapse over the next three years.

I don't expect we'll see a major long-term decline in value this time around. That's because we just finished one of those major declines earlier this year.

Instead, we'll likely see a minor pullback to skim off the bullish sentiment. That has already begun to play out. The yen has dropped nearly 10% since the September high.

The fall will likely continue until sentiment reverses.

The yen isn't grabbing headlines anymore. But we're still seeing the fallout from the yen-carry trade unwinding. And while the long-term trend is likely higher, we should expect a lower yen over the short term.

Good investing,

Brett Eversole