They Bet Against the Dollar. Now They’re Paying the Price.

The dollar was expected to weaken against a number of currencies this year. It hasn’t worked out that way.

Instead, the greenback has soared, squeezing traders who bet against the dollar and pushing central banks to protect their own currencies.

The clearest example of surprising dollar strength: its recent 34-year high against the yen.

The dollar has jumped by around 9% against the yen this year, according to FactSet. One dollar currently buys around 154 yen. The last time it was that level, George H.W. Bush was president, MC Hammer was a chart-topper, and the Nintendo Game Boy was the must-have gaming console.

The move has sent ripples through global markets, creating losses for hedge funds that lined up to bet on the yen and hitting the performance of exchange-traded funds that allow investors in the U.S. and elsewhere to buy Japanese stocks.

A weaker yen could also create ripples in the $27 trillion market for U.S. Treasurys, which have suddenly become much more expensive to Japanese investors. Japan is the largest foreign holder of Treasury bonds, and a change in its investing behavior could have a noticeable impact on demand.

So, what happened?

At the start of the year, markets were confident the U.S. Federal Reserve would cut rates in 2024, possibly as many as six times. That, in theory, should weaken the dollar, since it would make it less attractive for foreigners to buy bonds in the U.S.

U.S. economic data earlier this year sowed some doubts about the Fed’s path, but traders got reassurance in March: Fed officials projected three rate cuts before year-end, meaning dollar weakness should still have been in the cards.

In the same week, the Bank of Japan took a sharp turn in the other direction. It brought an end to an eight-year period of negative interest rates, raising rates and scrapping its commitment to keep government bond yields close to zero.

Differences in interest rates are a major driver of exchange rates. With rates set to head lower in the U.S. and higher in Japan, the stage appeared set for the yen to rally against the dollar. Fund managers lined up to bet on that move.

Traders in the U.S. took $114.4 billion of long positions in the yen against the dollar between Jan. 3 and April 9, an increase of 13.8% from roughly the same period a year earlier, according to data from the Commodity Futures Trading Commission. Many of these traders were getting ahead of the negative-rate announcement, which was widely anticipated.

But the trade backfired, thanks to the surprising strength of the U.S. economy.

Almost every part of the U.S. economy is booming, confounding economists who expected higher rates to be a drag. Retail sales are up, employers are in the midst of a hiring boom, and inflation has come in hotter than expected for three months running. Economists used to worry about recession: The latest Wall Street Journal poll shows recession fears are at their lowest level since April 2022.

Now, markets are pricing in only one or two rate cuts, and some investors think the Fed won’t cut at all this year. Fed Chair Jerome Powell said the central bank needed more time to gain confidence that inflation was under control before it starts cutting.

The U.S. Dollar Index, which measures the value of the currency against a basket of those of major U.S. trade partners, is up about 5% in 2024.

Wall Street currency analysts are now slashing their projections for the yen. On April 16, Bank of America said it expected the dollar to be worth around 155 yen by the end of the year; it had previously predicted a year-end exchange rate of around 142 yen per dollar. At the start of the year, investment firm T. Rowe Price expected the yen to trade at around 140 per dollar. It now thinks that the yen could sink to as much as 170 yen per dollar, said Quentin Fitzsimmons, a fixed-income portfolio manager at the firm.

Among the investors caught by surprise: RV Capital, a Singapore-based hedge fund with assets of around $1 billion. The firm had been betting on Japan’s economic growth since last year, using a mix of strategies such as buying inflation-linked bonds and currency swaps as well as betting the dollar would fall against the Japanese currency, albeit with an increase in volatility, said Ranodeb Roy, the money manager’s founder and chief investment officer.

The BOJ decision to raise rates as well as an increase in volatility have played out as expected, but the weakening of yen hasn’t, Roy said.

A fund operated by Hong Investment Advisors, an asset manager based in Hong Kong, shifted from a bet against the yen to one in favor of it around the time of the Bank of Japan’s interest-rate increase, said Shun Hong Liu, the firm’s chief investment officer. He said the fund, which is focused on currency and interest rates, took a hit on the yen but is still up around 8% this year—thanks to other positions meant to benefit from dollar strength against other currencies.

The dollar’s rally against the yen has also hit investors in Japan’s stock market, which has attracted plenty of interest from the U.S. this year. An iShares MSCI Japan exchange-traded fund that hedges the currency risk is up about 16% this year. The unhedged version is up just 4%.

Traders have now shifted their efforts to trying to predict when Japan will intervene to prop up its currency, something it did in September 2022 for the first time in decades. Japan’s finance minister has repeatedly said that all options are on the table to defend the currency.

Japan’s currency woes are being echoed elsewhere. Treasury Secretary Janet Yellen met her counterparts in Japan and Korea this week, and said the three countries acknowledged “serious concerns” about the depreciation not just of the yen but also of the Korean won. Indonesia’s central bank has intervened to prop up the rupiah after it sank to its lowest level in four years. The People’s Bank of China has allowed the yuan to move lower against the dollar after weeks of trying to protect the currency.

Will these central bankers and politicians need to do more to protect their currencies? That will depend in large part on that great unknown: how long the U.S. economic boom will continue.

Write to Weilun Soon at [email protected]