The Bank of Japan has a problem. That problem is the weakness in the JPY. You can see from the index chart below that JPY weakness has been pronounced this year.
The JPY being weak is great for Japan’s export economy. A weak domestic currency means that the country’s exports are of better value abroad. However, for the domestic economy, it means imports are more expensive. So, Japan’s domestic import market is pressured by the weak JPY and that creates political pressure to address it. Soaring US10-year yields, JGBs being capped, higher oil prices (Japan is a net importer of energy), and leveraged FX moves on a weak JPY have all contributed to the situation.
What can the BoJ do?
They have three key options.
- Firstly, it could hike rates. If it did this it would be a huge surprise and immediately send the JPY higher. STIR markets only see a 0.9% chance of a hike.
- Secondly, it could stop capping JGBs. This is the Japanese 10-year bond which is artificially kept at a band between 0.25% and -0.25% by buying bonds. If this cap is removed the JPY can strengthen.
- Thirdly, we get some kind of ‘official’ response on how JPY strength will be managed going forward including if/how/when JPY intervention might occur.
The Trade
The obvious trade on any hawkish BoJ development would be EURJPY shorts as the eurozone continues to head towards a recessionary environment.
