• Japan is about to go on a holidays for more than a week.
• Currency strategists are warning that this could lead to “flash crashes” in currency markets during the Asian timezone.
• The last time market liquidity was this thin for this long was in early January this year. Back then, some massive moves in the Japanese yen occurred, including against the Aussie dollar.

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The Scout Association’s motto is “be prepared”.

If you like to dabble in currency trading during the Asian timezone, especially in the Japanese yen, that motto is also appropriate for you next week.

Japanese markets will be closed from April 29 until May 6 for an extended Golden Week holiday, sapping a major source of liquidity for currency markets in Asia. Given what happened last time market liquidity was this thin for a prolonged period of time, it led to some wild price movements at the start of January this year.

Strategists warn similar price volatility, often referred to as a “flash crash”, could occur in Japanese yen pairs again next week.

The National Australia Bank’s FX strategy team, led by Ray Attrill, are alert to the danger, warning the combination of thin market liquidity and record short positions in the US dollar-Japanese yen cross among Japanese retail traders, often involving leverage, could lead to some wild price movements in the coming days.

“There will be six consecutive business days when the Tokyo FX market will be shut but the Tokyo Futures Exchange (TFE) and other retail exchanges will be open, including two rather than one Monday mornings for something negative to happen over the weekend to provoke a significant ‘risk off’, and Japanese yen positive, start to the week,” the NAB said in a note released earlier this week.

“The risk of a repeat of [the extreme volatility seen in early January] would therefore seem to be multiplied.”

This chart from the NAB shows the current open interest of traders in various currency pairs at the TFE.

Total open positions in the US dollar-Japanese yen and Turkish lira-Japanese yen crosses are now higher than was seen at the end of last year — just before the period of extreme volatility hit.

In dollar terms, short USD/JPY positioning among Japanese retail investors currently sits at $US2.2 billion, the highest level on record. Long TRY/JPY positions — reflecting an expectation that the lira will strengthen against the yen — also sits at a non-insignificant $US480 million.

According to the NAB, this leaves the JPY susceptible “to big up or down moves if TRY drops sharply or the USD surges during Golden Week”, especially as Japanese retail investors are able to enter trades with as much as 25 times leverage.

Positioning is lop-sided in these currency pairs, likely using leverage, during a period when market liquidity will likely be extremely thin — it’s easy to see why the NAB is warning over the potential for volatility equal to or even greater than what was seen in early January this year.

It’s not the only bank on alert for volatility.

“The below-normal liquidity raises the risk of ‘flash crashes’ such as that which occurred on 3 January when AUD/JPY temporarily slumped by 7%,” said Joseph Capurso, Senior Currency Strategist at the Commonwealth Bank in a note.

On that date selling in the AUD/JPY also pushed the AUD/USD slump by nearly three cents to below .6750 in a matter of seconds, leaving it at the lowest level since the GFC. It subsequently recovered all of those losses to close the day just above .7000.

That demonstrates that big movements in Japanese yen pairs can also influence other major currency pairs.

Given many are warning about the potential for heightened volatility, that could see many traders move to the sidelines next week, further exacerbating thin market liquidity. In turn, may also encourage some traders to try and trip stop-loss orders given it will be easier to push major currency pairs around with fewer participants in the market.

It promises to be an interesting period ahead, especially with a raft of major economic and central bank events scheduled in Asia during early May.

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