LONDON Hit by a whipsawing yen in the last two months, many FX hedge funds are still determined to bet the Bank of Japan will succeed in weakening the currency over time while the dollar climbs as the Federal Reserve withdraws its stimulus.
The Fed's first hints in May that it may start to pull back from its $85 billion dollars-per-month programme led to a rebound in the safe-haven yen as investors stampeded out of emerging markets and commodity currencies.
The average currency-focused hedge fund lost 0.58 percent that month and fell a further 0.92 percent at the start of June as the yen climbed, the Parker Global Currency Managers Index showed.
The average macro hedge fund, betting on global economic shifts across asset classes, lost 1.04 percent of its value in May and a further 1.59 percent in June, dragging these funds down half a percent for the first half overall, according to Hedge Fund Research.
The Fed's more recent indications that it will stick with its stimulus until later this year have eased some of the market's qualms, however, and some hedge funds are tiptoeing back into bets against the yen.
Robert Savage, chief strategist at currency hedge fund FX Concepts, said the fund was slowly re-entering dollar/yen trades "but not in as big a way as in the past."
The sense of caution is understandable: The dollar leapt 33 percent against the yen from mid-October to May, hitting a 4-1/2-year high of 103.74 yen on May 22, before pulling back a full 10 yen by mid-June.
One-month yen implied volatility rose steadily in May and June, eventually hitting its highest since March 2011 as the dollar lurched lower against the yen.
Questions also remain over how far the yen could slide, and against which currencies.
"I think you still sell the yen but how far do you chase it? There have been some really stiff moves...so you need to be careful what you trade it against," said a manager at a leading FX hedge fund.
The yen's long slide was fuelled by expectations for an aggressive loosening of Japanese monetary policy under a new prime minister determined to drag the economy out of decades of stagnation, making short positions on the yen combined with long positions on Tokyo stocks an easy bet.
While the yen slid, Tokyo's Nikkei stock index .N225 rose 87.8 percent from mid-October to the end of May.
"It was a trade that can be popped into the 'no-brainer' category," said Michael Petley, Chief Investment Officer at the ECU Group, which manages currency exposure for companies.
Meanwhile, the Fed's stimulus drove market participants into higher-yielding equities and emerging market assets.
"To be long of EM, commodity (currencies) etc and short the yen, was an all-encompassing, knockout trade. But the market had lost the ability to price risk properly."
That's why markets were caught unawares when Fed chief Ben Bernanke indicated in late May that the central bank was contemplating winding down its stimulus. Growing evidence that China's economic growth was slowing was a further blow.
Stocks plummeted - including the Nikkei, bond yields rose and market players opted for the safety of the yen while hastily trying to unwind positions in emerging and commodity currencies.
Ortus Capital Management, which manages multiple funds and accounts trading over $1 billion in assets in total, saw its FX fund lose 2.95 percent in May and 0.75 percent in June, leaving it down 13.76 percent year-to-date, data seen by Reuters showed.
Ortus did not respond to Reuters' request for a comment.
The Newedge Trend Indicator, a model-managed futures portfolio, has been short the yen against the dollar for the past 245 days, said James Skeggs, global co-head of the advisory group at broker Newedge.
This year, the trade has added 2.39 percent to the model portfolio's overall returns. But Skeggs said it lost 0.23 percent for the overall portfolio in June.
But with U.S. Treasury yields rising on expectations the Fed will eventually pare back its stimulus while most other major central banks stick to easy policies, fund managers say the dollar's uptrend is intact.
Currency speculators increased their bets in favour of the dollar and against the yen in the week of July 9, Commodity Futures Trading Commission data showed.
"Most macro managers still believe the yen will weaken, but their positions are lighter than at the start of the year. In the near term, they believe the pace of the decline will be a bit more muted," said Akshay Krishnan, a senior research analyst at hedge fund investor Stenham Asset Management.
However, some in the market say the recent dollar/yen slide helped shake out a previously congested trade.
"People are still bullish dollar/yen but don't hold the trade," said Neil Jones, head of hedge fund FX sales at Mizuho Corporate Bank. "That is a powerful force, when the view is in place but not the position. It is highly indicative that the pair will go higher."
(Additional reporting by Tommy Wilkes and Laurence Fletcher, Editing by Nigel Stephenson and Hugh Lawson)