Currency carry traders are increasingly turning to the Swiss franc as intervention threats and elevated interest rates diminish the yen's appeal as a funding currency.

Latest data from the Commodity Futures Trading Commission (CFTC) shows that through the week ending August 11, hedge funds have pushed net short positions on the franc to a near two-month high. Meanwhile, they have trimmed bearish yen bets for a second consecutive week.

Hedge Funds Short Franc as Funding Costs and Intervention Risks Take Center Stage

Tobias Jungmann, head of foreign exchange options for the Americas at Bank of America in New York, noted that "the market has recently added short franc positions to finance FX carry trades." He also pointed out that the volatility-to-carry ratio for emerging market trades funded by the franc makes options an effective way to gain exposure while limiting risk.

The franc's funding appeal stems from Switzerland's near-zero interest rate environment and the Swiss National Bank's willingness to curb sharp franc appreciation. By contrast, late July saw US and Japanese authorities jointly push the yen higher, which directly spiked yen volatility and made investors wary of yen-funded trades. Last week, sources indicated that the Japanese government supported the central bank's recent rate hike.

Higher yield differentials are enhancing the franc's attractiveness as a funding currency. Data shows that over the past month, a strategy of borrowing francs and investing in the high-yielding Mexican peso delivered cumulative returns near 4%, while the same approach using yen funding yielded only 1.3%. In simple terms, carry trades involve borrowing low-yielding currencies and investing in higher-yielding ones to profit from the interest rate spread.

Stephen Jefferies, head of FX and emerging markets at JPMorgan in London, said, "The massive interventions in 2024 badly damaged yen carry trades, and market participants remain wary of that experience." He added that demand for alternative funding currencies such as the franc, euro, and even the New Taiwan dollar has picked up recently.

Yen's Long-Standing Dominance as Funding Currency Remains Intact

Nevertheless, the yen has long been the preferred funding currency for carry trades and still retains support from some industry professionals. The Bank of Japan's 1% policy rate is lower than most developed markets, and concerns over Japan's long-term fiscal health continue to weigh on the currency. The yen has already given back more than half of its post-intervention gains.

"The yen remains the world's primary funding currency, and recent interventions have not changed that fundamental reality," said Marcus Schmidt, head of European linear FX and local market rates trading at Credit Agricole. As long as the yield gap between Japan and other economies persists, carry traders will keep shorting the yen.

Graham Smallshaw, senior FX spot trader at Nomura Singapore, said the firm has indeed observed renewed interest in long yen crosses (EUR/JPY, AUD/JPY, and NZD/JPY) during the recent yen pullback. These trades are primarily executed through Euro-style reverse knock-out options (ERKO).

Some market participants, however, believe the franc remains the more favored funding choice, at least for now. Steve Brice, global chief investment officer at Standard Chartered in Singapore, stated plainly, "Franc carry trades are more popular. We are seeing more carry trade flows coming from the franc."