Investors Explore European Currencies for Yen Bets Amid Dollar Uncertainty

Amidst persistent market volatility, investors are seeking innovative strategies to capitalize on diverging interest rate paths across major economies. To circumvent dollar-based volatility, some are turning to European currencies as a means to fund bets on the Japanese yen.

With Donald Trump's trade tariff proposals casting uncertainty on markets, the reliability of the US dollar as a benchmark is being questioned. Consequently, investors are exploring alternative approaches to navigating the yen's potential strength.

Several asset management firms, including Vanguard, Russell, BlueBay, and Candriam, are employing strategies that involve shorting European currencies such as the euro, Swiss franc, and pound against the yen. The rationale behind this is that these currencies offer higher potential returns and are perceived as less risky than betting against an increasingly unpredictable dollar.

"By using European crosses, investors can access the yen trade without the inherent dollar risk," said Adrian Boehler, Global Head of Macro Distribution at UBS Group AG. "This allows them to express conviction in the yen without the headline risk associated with Trump's tariffs."

After a period of sustained weakness, the yen appears poised to shed its reputation as a low-yielding currency. The Bank of Japan has indicated its intention to continue raising interest rates, signaling an end to deflation in Japan.

Given the prospect of aggressive rate cuts to bolster economies in Europe, investors are particularly interested in backing the yen against European currencies. The European Central Bank is expected to cut rates at least three more times this year, while the Federal Reserve is likely to implement only one cut. This divergence is anticipated to weaken the euro.

Meanwhile, signs of wage growth in Japan suggest that the Bank of Japan may raise rates again in 2025. As a result, the yen has gained approximately 2% against the Swiss franc, sterling, and euro since January. This marks the yen's strongest start to the year against the Swiss and British currencies since 2017.

"Economic and political factors are exerting downward pressure on the euro against the yen," said Juntaro Morimoto, Senior Analyst at Sony Financial Group Inc. Citigroup, Rabobank, and Danske Bank anticipate that the euro will end the year below 150 yen, with Danske forecasting a 12% drop to 141 yen.

Options market signals reflect diminished sentiment toward European currencies versus the yen. Risk reversals for the Swiss franc against the yen are approaching their most bearish levels in two months, indicating growing demand for protection against a decline to 160 yen.

Despite ongoing euro-dollar volatility, euro-yen volatility has remained relatively muted. This narrowing spread suggests that investors are increasingly willing to circumvent dollar-related noise in favor of bets on a strong yen.

Mark Dowding, Chief Investment Officer at Bluebay, expressed his strategy of buying the Japanese currency against the euro and pound to capitalize on its strength. Ales Koutny, Head of International Rates at Vanguard Asset Management, revealed that he began purchasing the yen against the franc in December, along with the euro and South Korean won.

"The yen, once one of our preferred shorts, has now become one of our preferred longs," said Koutny.