(Bloomberg) -- The yen is facing growing risks it will rebound against the dollar because trader positions betting it will weaken have become stretched, reaching record levels.

Heightened Middle East tensions and speculation Japan may intervene in the market to support the yen are putting pressure on investors to unwind so-called carry trades. Those deals involve borrowing yen cheaply to park money in higher-yielding assets.  

Bets by leveraged funds and asset managers on yen weakness increased to more than 173,000 contracts through April 16, the most on record in Commodity Futures Trading Commission data going back to 2006. It’s also the biggest short position among nine major currencies, according to Bloomberg calculations, making the yen especially vulnerable to a snapback.

The risks of too many investors piled into one currency position can be seen in the plunge in the Mexican peso this month as investors jettisoned heavy carry trade positions. Japan’s wide yield gap with the US helped drag down the yen to its weakest in about 34 years against the dollar last week, prompting Japanese officials to warn that they may take action in the foreign-exchange market.

“Yen-selling positions have accumulated to high levels because of the investor conviction that monetary policy both in Japan and the US will remain unchanged for the time being,” Koji Fukaya, a fellow at Market Risk Advisory in Tokyo, wrote in a research note. “The yen could rally should weakness in the US economy become pronounced in data, market volatility jump or risk aversion strengthen, all of which are hard to predict.”

As the dollar keeps rising, the US, Japan and South Korea said in a trilateral statement released last week that they will continue to consult closely on foreign-exchange market developments. They also acknowledged serious concerns that Japan and Korea have about the recent sharp depreciation in their currencies. 

The dollar has faced appreciation pressure from expectations the Fed will delay the timing of its start of interest-rate cuts. In contrast, the Bank of Japan’s first rate hike since 2007 in March failed to boost the yen on the view it will only gradually increase rates. 

Foreign banks’ lending in Japan to their main offices — a key indicator of demand for yen-funded carry trades — has remained elevated since the start of the Fed’s aggressive rate hikes in March 2022, which widened the policy divergence between the Asian nation and the US.

“The risk of yen appreciation due to unwinding is gradually increasing,” said Hirofumi Suzuki, chief currency strategist at Sumitomo Mitsui Banking Corp. in Tokyo. “But, with the Federal Reserve unlikely to deliver its interest-rate cut anytime soon, it’s hard to see such a position adjustment coming through.”

(Updates with futures position chart)

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