(Bloomberg) -- As Japan enters a six-day New Year break, a sense of anxiety over the possibility of another flash crash is gripping currency traders.
The Financial Futures Association of Japan has already warned of market instability as the holidays create a liquidity vacuum. Meanwhile, importers are preparing to deal with a potential repeat of the turmoil that took place on Jan. 3 this year, when the yen gyrated wildly and surged against its peers.
One red flag to watch for this time is the Turkish lira.
Japan’s retail investors speculate on a number of currencies, and are currently most bullish on the lira, according to data from the Tokyo Financial Exchange Inc. At the same time, Turkey’s currency has slumped more than 11% against the yen this year, opening up the prospect of forced liquidation of margin positions if losses increase.
“Caution is needed with regard to the Turkish lira against the yen,” said Takuya Kanda, general manager at Gaitame.com Research Institute Ltd. in Tokyo. “Any market shock could spur stop-loss selling on retail investors’ bloated lira-yen positions, which may see a broader surge in the yen.”
READ: Japan’s Margin Traders: Why They Matter for Currency Markets
Retail traders take a contrarian view and go into the market when prices dip, typically having a moderating effect on currency moves, according to research from Japan’s central bank. But when their bets go wrong, the results can be dramatic.
That’s what happened in the early hours of Thursday, Jan. 3, when the sell-off in the lira and the Australian dollar against the yen triggered an automatic liquidation of investors’ loss-making positions. Algorithmic programs and the absence of Japanese banks only exacerbated currency moves as the yen soared almost 8% against the Aussie and 10% versus the lira within minutes.
With banks being shut from Tuesday until Jan. 5, investors may not be able to respond to margin calls and risk seeing forced liquidation, the Financial Futures Association warned in a statement this month.
Click here to read more about how Japan’s extended holidays impact markets
That said, not everyone is convinced another flash crash is likely.
“Since the yen became one of the weakest currencies this month, it is reasonable to expect it to rebound next month,” Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo, wrote in a report Monday. “However, we don’t expect a flash crash repeat in the dollar-yen during this week even with Japan on holiday.”
One reason for such a view is that net yen short positions held by hedge funds are about 80% lower than they were at the start of 2019, according to data from the Commodity Futures Trading Commission.
Japanese margin-trading companies will as usual evaluate their client positions every day during the break except for on Jan. 1, according to Kanda of Gaitame.com Research, part of Japan’s leading internet platform for retail investors.
Importers are probably leaving orders to buy dollars in case of a plunge during the holidays, according to Resona Bank Ltd. The dollar-yen rate dropped 0.2% to 108.63 as of 9:58 a.m. in New York on Tuesday, on track for a third day of losses.
“We have seen dollar buy orders gathering around 105 yen to 107 yen,” said Keiichi Iguchi, a client manager at Resona in Tokyo. “We can’t rule out risks of a slide in dollar-yen, but it’s unlikely that we will see moves like Jan. 3.”
READ: Now Is a Good Time to Buy the Yen Versus Dollar, History Shows
(Updates prices in penultimate paragraph)
--With assistance from Katherine Greifeld.
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