China widened its export control regime to cover more Japanese entities, adding 20 organisations to its list and putting another 20 under closer monitoring. The rules bar exports from China with commercial or military applications to the blacklisted firms, and also constrain overseas suppliers from providing Japanese companies with dual-use technology originating in China. The targets include defence-related institutes, Mitsubishi units, Mitsui E and S, and Japan Nuclear Fuel, a move that increases supply chain risk for rare earths and defence manufacturing.
Japan’s May commercial sales totalled ¥52.549tn, up 5.0% year on year and 1.4% month on month on a seasonally adjusted basis. Wholesale sales rose 4.9% to ¥39.102tn, while retail sales increased 5.3% to ¥13.447tn; within wholesale, mineral and metal materials and machinery gained, whereas pharmaceuticals declined. Markets were steady, with the Nikkei up 0.15% at 69,468, USD/JPY at 161.86 (+0.075%) and the 10-year JGB yield at 2.64% (+1.9bp). Flow data showed inflows into USD and NZD, outflows from CAD, JPY and NOK, and JPY scored holdings turning negative.
Market Positioning and Potential for a Yen Reversal
We see a major disconnect between the market’s bearish positioning on the Yen and supportive underlying factors. Traders are still selling the Yen, pushing USD/JPY toward 162, even as geopolitical risks and strong domestic economic data flash warning signs. This crowded trade is ignoring the building pressure for a potential reversal.
China’s decision to expand its export control list to include more Japanese firms significantly raises supply chain risks, particularly for rare earths. We saw a similar situation in 2010 when China restricted rare earth exports, causing a major market shock and strengthening the Yen. The current tensions related to defense manufacturing could easily trigger a similar risk-off move that benefits the Yen.
The strong Japanese commercial sales data, which rose 5.0% year-over-year in May, adds pressure on the Bank of Japan to act. With Japan’s core inflation rate holding above the central bank’s 2% target for more than two years now, the justification for intervention to support the currency is growing stronger. The Ministry of Finance has historically stepped in to defend the Yen around these levels, most notably in 2022 and 2024.
Volatility Strategies and Risk Management for USD/JPY
Given this setup, we are positioning for a sharp increase in volatility in the coming weeks. We believe buying options, such as at-the-money USD/JPY straddles, is a prudent strategy to profit from a large price swing in either direction. This allows us to capitalize on either a sudden risk-driven rally in the Yen or a final, exhaustive push higher in the pair.
For those already holding long USD/JPY positions to capture the interest rate difference, we recommend hedging this exposure. The persistent JPY outflows show this is a very crowded trade, making it vulnerable to a rapid unwind. Buying cheap, out-of-the-money puts on USD/JPY offers a cost-effective way to protect against a sudden reversal.
