The yen's drop against the US dollar to its weakest level in nearly 40 years has prompted a growing number of Wall Street institutions to bet on faster interest rate increases by the Bank of Japan to curb inflationary pressures and stabilize the currency.
SocGen, Natixis, and Barclays all argue that the persistently weak yen could push BOJ Governor Kazuo Ueda to adopt a more hawkish monetary policy stance in the coming months. Analysts point to worsening fiscal concerns in Japan, rising international oil prices, and the widening US-Japan interest rate differential as key factors continuously weighing on the yen. At the same time, the yen's depreciation is driving up the cost of imported goods, further intensifying domestic inflation.
Where to begin
SocGen strategists Stephen Spratt and Reo Sakida note that rising energy prices, the yen's ongoing weakness, and faster cost pass-through to consumers are becoming growing concerns for the BOJ. Based on this view, the analysts recommend shorting 5-year Japanese government bonds and going long on 30-year JGBs to bet on further flattening of the yield curve. This week, the 40-year JGB yield briefly climbed to 4.01%, approaching the 4.355% historical high set in May. Meanwhile, the yen weakened to 163.99 against the dollar, its lowest since November 1986.
Why only a handful of banks are hawkish
Natixis Asia-Pacific strategist Dayeon Hong says that with USD/JPY breaking above 163, the likelihood of the BOJ delivering a stronger hawkish signal at its July 31 policy meeting is rising. She advises investors to position in two-year yen interest rate swaps to benefit from further rises in short-end Japanese rates. Hong adds that as market expectations shift, the pace of BOJ rate hikes could outpace current pricing. The market widely expects the central bank to keep rates unchanged at next week's meeting, after having raised its benchmark rate to 1% last month, the highest level in 31 years. Interest rate swaps now price in around 32 basis points of total rate hikes by the end of the year. However, a Bloomberg survey shows that roughly half of economists still predict the BOJ will wait until December for its next move.
In contrast, Barclays forecasts the BOJ will hike rates next in October, followed by another increase in April next year. Barclays analysts Naohiko Baba and Takashi Onoda say that to stem the yen's persistent decline and buy time for the next rate hike, Governor Ueda is expected to send as hawkish a signal as possible at the July 31 policy meeting and subsequent press conference, including a more aggressive stance on the timing of the next rate increase.
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