(Feb 24): Traders hoping to profit from large swings in the dollar-yen may be in for a rude awakening as the currency pair risks being trapped between rising intervention odds and US interest-rate bets.

One-month implied volatility on the dollar-yen, a measure of its expected movement over the period, may fall to its lowest level since March 2022, strategists said. Fueling that decline is the pair’s narrowing daily trading range which is due to duelling forces capping moves both ways.

“Dollar-yen appears to be caught between the Ministry of Finance threatening intervention on the topside, while the Bank of Japan talking down the chance of rate hikes is supporting the exchange rate on the downside,” said David Forrester, a senior foreign-exchange strategist at Credit Agricole CIB in Singapore.

The currency pair’s one-month implied volatility rose as high as 8.14% last week as investors factored in the BOJ’s monetary policy decision on March 19. That rebound may end up being short-lived.

Forrester said the paring-back of Federal Reserve rate expectations following strong US inflation data is also limiting the downside to dollar-yen. The largest daily range last week was just ¥0.75, compared with over two yen in early January. Japan’s currency is trading at around ¥150.50 against the dollar in Asia Monday.

With the currency pair looking vulnerable to becoming trapped at around ¥150, option traders will be watching to see if Japan’s inflation data on Feb 27 can be the catalyst for it to break out of a narrow range. BOJ governor Kazuo Ueda last week signaled continued confidence over the prospects of achieving stable inflation, which some analysts said was an indicator of policy change.

If the yen doesn’t break out of its range, then implied volatility for the dollar-yen appears likely to continue its slide.

“Our base case is for one-month volatility to drift lower to the 6.25-6.75 region in the coming weeks,” said Ruchir Sharma, global head of FX option trading at Nomura International Plc. This is due not only to forces keeping the currency pair rangebound, but also trading factors that may come into play, he said.

Some clients have put on option positions that benefit from a slow move higher in the currency pair in the coming weeks, London-based Sharma said. “Dealers would need to sell dollar-yen volatility to hedge themselves to compensate for the increase in the value of these trades, further depressing volatility,” he said.

An example of such a trade would be a purchase of call option contract with a reverse knock-out condition included. In this scenario the value of the call option increases as the dollar-yen rises, with the caveat that if the currency pair rises high enough to hit the knock-out level before the contract expires, it becomes worthless.