From a rising yen to debt market derivatives, market signals reveal how investors are going for some cheap but fail-safe options to make money on the off chance the Bank of Japan surprises them with a tweak to policy settings this week.
The trading pattern in the run-up to the BOJ's two-day meeting, which ends on Friday, is familiar: Investors have been betting all year the BOJ will finally relent on its stubborn ultra-easy monetary stance and adjust its yield curve control.
But this time, wary of repeated past disappointments, many investors are avoiding direct and potentially expensive bets such as short-selling Japanese government bonds (JGBs), a trade often referred to as the "widow-maker" for the crushing losses it inevitably generated.
They have instead bought back the yen, and positioned through the bond options market for a spurt in volatility, giving themselves room to gain from a variety of outcomes.
At the same time, the rally in the weak yen and the apparent absence of short-selling of JGBs is giving the BOJ room to move without a wild reaction in markets.
"Speculative positioning is relatively light, and this presents a good opportunity for the BOJ to take its next incremental move," said Jimmy Lim, chief investment officer at Singapore-based Modular Asset Management.
Lim thinks the odds of an adjustment to yield curve control (YCC), which keeps short-term yields negative and caps 10-year yields at 0.5%, are 60 to 40. He is thus positioned in derivatives, to benefit from market swings in either direction on the day.
The options market benchmark for expectations of JGB volatility (.SPJGBV) has tripled to 9.1% in the past month, as investors cottoned on to the idea that, while trying to second-guess BOJ policy decisions could be risky, there was less to lose from betting on a volatile market reaction one way or the other.
Analysts at ING pointed to evidence of how nervous markets were in the price of one-week risk reversals, where the premium for buying yen over selling it was trading at 4.1%. That was the most extreme skew towards a stronger yen since March 2020.
SLOWLY, STEADILY
Investors think it is time, however, for new BOJ Governor Kazuo Ueda to at least unwind the YCC element of his predecessor's complex policy, given how much YCC has unduly distorted long-term yields, constricted bond markets and crushed bank profits from lending.
"Even if they tweak it, it doesn't mean that they will turn totally hawkish," said Nigel Foo, head of Asian fixed income at FSI. "If you look at it in the context of the amount of rate hikes the Fed has already delivered, it's immaterial."
When former BOJ governor Haruhiko Kuroda unexpectedly doubled the YCC band to 50 basis points in December, he called it a technical adjustment to make stimulus more sustainable.
Jim Leaviss, chief investment officer for public fixed income at M&G Investments, also points to the weak yen, among other factors, as a reason the BOJ would be keen to tweak YCC.
In the run-up to the BOJ meeting, the yen has settled near the middle of the wide extremes of the past month, when it surged from a nearly eight-month trough at 145 per dollar to a multi-week high near 137. The benchmark 10-year JGB yield also retreated to 0.445% from as high as 0.485%.
Leaviss said his fund is long the yen, but does not sell JGBs short.
"We don't short the JGB market. In part, it's an expensive thing to do - as you know, the Bank of Japan owns 110% of the 10-year JGB market," he said.
Michael Michaelides, an analyst on Carmignac's fixed income team, is positioned via both JGBs and the yen for the higher odds the BOJ removes its yield bands this week. Ales Koutny, head of international rates at Vanguard, only sees a 50% chance of a move and yet holds short JGB futures in readiness.
James Athey, investment director of rates management at abrdn, is also underweight Japanese bonds and long the yen and says the BOJ needs to seize the opportunity "to get policy in a less extreme place".
"Nobody's calling for them to hike aggressively, just bringing some function back to the JGB market, allowing themselves to step away because the data has given them an opportunity to do so. It just seems prudent," Athey says.
