Investors cautiously position for unlikely BOJ policy change

Investors cautiously position for unlikely BOJ policy change

Investors Seek Cheap but Safe Options Ahead of Bank of Japan Meeting

Bank of Japan

In the lead-up to the Bank of Japan’s (BOJ) two-day meeting, investors are cautiously looking for cheap yet secure investment opportunities in case the central bank surprises them with a change in policy settings. Market signals indicate that investors are taking a different approach this time, avoiding risky strategies and instead opting for a more cautious stance to protect their investments.

The BOJ has been known for its stubbornly ultra-easy monetary policy, but investors have been betting throughout the year that the central bank will finally adjust its yield curve control. However, wary of past disappointments, many investors are avoiding direct and potentially expensive bets, such as short-selling Japanese government bonds (JGBs), which have earned the moniker “widow-maker” due to the significant losses it tends to generate.

To mitigate potential losses, investors have instead begun buying back the yen and positioning themselves through the bond options market, anticipating a spurt in volatility. This strategy allows them to benefit from a variety of outcomes. The rally in the weakened yen and the absence of JGB short-selling provide the BOJ with space to make its next move without causing wild market reactions.

Jimmy Lim, the chief investment officer at Singapore-based Modular Asset Management, believes that speculative positioning is relatively light, presenting a good opportunity for the BOJ to make its next incremental move. Lim positions himself in derivatives, allowing him to benefit from market swings in either direction on the day of the announcement.

The options market benchmark for JGB volatility expectations has tripled to 9.1% in the past month, indicating that investors recognize the value of betting on a volatile market reaction rather than attempting to predict the BOJ’s policy decisions directly. Analysts at ING have observed evidence of nervousness in the price of one-week risk reversals, highlighting the extreme skew towards a stronger yen since March 2020.

Slowly, Steadily

BOJ sources suggest that the central bank is leaning towards keeping its yield control policy unchanged as policymakers wait for data to affirm rising wages and inflation. However, investors believe that it is time for new BOJ Governor Kazuo Ueda to at least unwind the yield curve control element of his predecessor’s complex policy. Yield curve control has unduly distorted long-term yields, restricted bond markets, and negatively impacted bank profits from lending.

Nigel Foo, the head of Asian fixed income at FSI, explains that even if the BOJ tweaks its policy, it doesn’t mean they will become wholly hawkish. Comparing it to the rate hikes implemented by the Federal Reserve, he describes the potential adjustments as inconsequential.

When former BOJ Governor Haruhiko Kuroda doubled the yield curve control band to 50 basis points in December, he presented it as a technical adjustment to make the stimulus more sustainable. Jim Leaviss, the chief investment officer for public fixed income at M&G Investments, highlights the weak yen as one of the factors that would motivate the BOJ to make changes to the yield curve control.

Throughout the lead-up to the BOJ meeting, the yen has remained relatively stable, settling near the middle of the wide extremes observed in the past month. The benchmark 10-year JGB yield has also retreated. Leaviss mentions that his fund is long on the yen but doesn’t engage in short-selling JGBs due to its expensive nature and the fact that the BOJ owns 110% of the 10-year JGB market.

Michael Michaelides, an analyst on Carmignac’s fixed income team, is positioned in both JGBs and the yen, anticipating higher odds of the BOJ removing its yield bands this week. Ales Koutny, the head of international rates at Vanguard, believes that there is only a 50% chance of a move but still holds short JGB futures in readiness.

James Athey, the investment director of rates management at abrdn, is underweight Japanese bonds and long on the yen. He suggests that the BOJ should take the opportunity to bring its policy to a less extreme place while still being prudent and not aggressively hiking rates. According to Athey, the BOJ needs to allow some function to return to the JGB market, giving themselves a chance to step away.

In conclusion, as the Bank of Japan’s meeting approaches, investors are seeking cheap and safe options to protect their investments. This cautious approach reflects the desire to avoid risky strategies and the reluctance to engage in short-selling JGBs, which have historically resulted in substantial losses. By buying back the yen and positioning themselves through the bond options market, investors can benefit from potential market swings while avoiding direct bets on the BOJ’s policy decisions. The volatility in the options market and the absence of JGB short-selling offer the BOJ room to adjust its policies without causing unexpected reactions in the market. As the new BOJ Governor takes charge, there is growing consensus among investors that it is time to unwind the yield curve control element of the central bank’s policy. Nevertheless, investors believe that any adjustment made by the BOJ will not lead to a completely hawkish stance. With the yen and JGB yields stabilizing, investors are cautiously optimistic about potential market outcomes and eagerly await the BOJ’s next moves.

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