Hedge funds are increasingly targeting the euro for short trades against the yen, driven by speculation that the Bank of Japan (BOJ) will raise interest rates and political uncertainty in Europe, according to a report by Bloomberg citing data from the Depository Trust & Clearing Corporation (DTCC).

DTCC euro-yen options activity has seen a sharp rise, with trading volumes exceeding $3bn on multiple days in recent weeks. The pair's three-month implied volatility — a key gauge of anticipated price swings — has reached its highest level since August, signalling heightened demand for options tied to the currency pair.

The report cites Graham Smallshaw, Senior FX Spot Trader at Nomura Singapore, as highlighting that macro funds are now favouring short euro-yen trades over short dollar-yen, and that traders are gravitating toward complex downside options strategies, such as put butterflies or dual digital options, rather than straightforward put options.

Macro hedge funds, which aim to capitalise on large-scale market shifts, are betting on further yen appreciation, fuelled by mounting speculation that the BOJ will raise rates by 25 basis points this month, following recent hawkish comments from BOJ Governor Kazuo Ueda.

The euro is under additional pressure from weak economic data in the Eurozone and fears of political instability in France, with the government at risk of being partially toppled by a no-confidence vote scheduled for Wednesday.

The yen, meanwhile, is trading near its strongest levels against the euro since December 2023, as investors increasingly view the Japanese currency as a safe haven.