Yen Step Back, Two Steps Forward
Updated
Despite sharp inflation, the Bank of Japan (BOJ) left YCC unchanged on March 10th. This was Haruhiko Kuroda’s last meeting as BOJ Governor. Japan is still struggling to stoke growth at risk of sustained stagflation. Hence, his decision to leave rates intact was no surprise.
Kuroda left the YCC unchanged. Analysts expected him to scrap the YCC so that the new incoming governor, Kazuo Ueda could start afresh. Hopes of change are now expected at the next BOJ policy meeting on April 27th.
Kuroda leaves behind a mixed legacy. His strong monetary stimulus lifted the Japanese economy out of deflation at the cost of hurting bank profits with ultra-low rates. Growth has remained tepid.
Kuroda has been a source of stability. More than what was needed in the staid land of the rising sun. Now, the monetary policy landscape is expected to shift as Ueda takes charge.
New BOJ leadership and an aggressive US Fed will create near term weakness in JPY followed by medium term strength.
This case study analyses a two staged positioning in CME Japanese Yen Futures to harness yield from anticipated currency moves.
Change of Guard at the BOJ
Under the new governor, definitive shifts are afoot. Inflation in Japan is non-negative. Really? Yes. Not only non-negative but also at levels unseen in 43 years.
Kuroda may not have radically transformed Japanese economy, but he managed to revive its equity market. The risk of uncertainty and volatility exists once he leaves the office.
Markets are used to perennial Japanese low inflation, and to a consistent central bank leadership. Both are now going or gone.
Another big shift is BOJ's more definitive independence. While separate from Government of Japan, BOJ was seen as being an integral part of Abenomics to snap out of deflation. The Kishida-Ueda relationship is different.
Prime Minister Kishida has not outlined a particular direction on macroeconomic policy. Politically, the LDP is far from united, not least on fiscal and monetary policies. Kishida’s base of support within the party is fragile, and his approval ratings have been in a prolonged slump.
As a BOJ governor, Ueda comes from an unconventional background. He is the first academic to assume leadership of BOJ. He has not managed a large organization. He is knowledgeable about monetary policy and is a protege of Stanley Fisher.
What, then, can we expect from Ueda? He is not convinced that inflation is sticky. Ueda maintains that “…inflation is led by cost-push factors” and “it will still take time to achieve sustainable inflation.” It does hint that he isn't someone who will make any sudden major moves.
That said, in a parliamentary hearing earlier this month, Ueda hinted that the current YCC was unlikely to survive. Engaging the market is essential he said before adding that “in some cases, adding a surprise factor is unavoidable.”
There is growing evidence emerging from the annual “shunto” (a big wage negotiation between unions and employers) that workers are asking for the largest raise in base pay in 25 years.
Some Japanese employers have already raised wages sharply higher with case in point being Fast Retailing (a Japanese listed firm and parent company of Uniqlo) which raised pay by 40% earlier this year.
Until now, it has been possible to attribute Japan’s inflation to the rise in the cost of imports driven by weak yen. Big wage increases would change that.
However, the latest data, published Tuesday, shows that wage growth is not rising as fast as expected. In cash terms, it reached the highest level in decades last year, but the January figure was far lower. Real wages adjusted for inflation have been falling the most since 2009.
Balancing growth while keeping inflation under control is not a small feat.
Next BOJ policy meeting is more than a month away. Meanwhile, the US Fed is becoming more hawkish in its fight against domestic inflation. Another rate hike by the US Fed will further weaken the fragile Yen.
The US macro environment is making an already complicated situation even more difficult. The failure of Silicon Valley Bank along with closure of Signature Bank and Silvergate Bank is testing the Fed’s wit. US Inflation continues to remain hot and three times the Fed’s target. With the liquidity backstop in place, the Fed is likely to jack up its rate by another 25 basis points when it meets on March 22nd. CME’s FedWatch tool pegs the likelihood of that happening at 82% as of March 14th.
Against that backdrop, Ueda could do one of the three once in office – (1) further widen the 10-year JGB interest rate band, (2) target shorter term yields & thereby reduce JGB holdings, and (3) abandon yield targeting altogether.
Options Markets are Bullish JPY/USD
Options on CME’s Japanese Yen futures have an overall Put/Call ratio of 0.56 across all expiries, indicating that investors are expecting the Yen to weaken.
In sharp contrast though, options for the July contract show a deviation from the trend with a Put/Call ratio of 2.6x. This coincides with the release of the 2nd Outlook Report by the BOJ after Ueda takes over, indicating the market expectation on Yen’s reversal versus USD starting July.
How much more JGB can BOJ keep buying to sustain YCC? Can this last?
Last December, the BOJ tweaked its YCC policy, to allow the 10-year Japanese Government Bonds (JGB) yield to move 50 basis points (bps) on either side of its 0% target, wider than the previous 25 bps band. The move stunned markets as BOJ hinted at monetary tightening after having stuck to its ultra-loose policy stance for a long time.
YCC tweak spilled over into January as BOJ was forced to purchase a record 182B of JGB to defend its higher yield cap from breaching the ceiling of 0.50%. The BOJ now holds more than 50% of JGB, making the situation ever more unsustainable. Adding to the JGB burden, BOJ also owns the majority of domestically listed exchange traded funds (ETFs).
Besides massive JGB purchases, the BOJ remodeled in January a funds-supply operation into a tool to prevent yields from rising rapidly.
Beyond the current short-term loans, the BOJ amended the rules to offer funds extending up to 10 years with variable rates. In January, BOJ provided loans of 3T Yen in the January offer before extending the terms of the loan to 10-year for subsequent loans. In February, BOJ tweaked the fund-supply policy terms, including the quadrupling of minimum lending fee from 0.25%-1%, to limit the short-selling of JGB’s, this indicates that the BOJ is having to use all tools at their disposal in order to defend JGB yields from rising above their defined cap.
The BOJ defended yet another attack on the YCC again in February prompting a further 2.2B of JGB purchases to keep yields from breaching the ceiling.
Economists anticipate that Ueda will fundamentally revisit YCC before BOJ lands in crisis.
Ueda starts on April 9th. It is unlikely that he will make any radical moves instantly.
Meanwhile, Fed Chair Powell is going all guns blazing to tame inflation down. Jobs data released last Friday showed the creation of 311,000 jobs smashing expectations of 225,000 jobs indicating a tight labor market. A strong labor market risks fueling a wage-inflation spiral, leaving the Fed with no choice but to jack up rates further.
Two Stage Trade Setup to Gain from Near Term Weakness & Medium-Term Strength
CME’s Japanese Yen Futures provides investors an exposure of 12.5 million Japanese Yen for every lot with the price quoted in USD per JPY increment. Every 0.0000005 change in JPY provides an increment of $6.25 in contract value.
With the USD expected to strengthen in the near-term, JPY will weaken until the next policy meeting on April 27th. As such a short position using CME Japanese Yen futures expiring in June (6JM2023) would provide a reward-to-risk ratio of 0.6x.
Stage 1
Stage 2
Thereafter, if Ueda starts to steer Japan’s monetary policy stance differently, JPY will start to strengthen in the medium term.
Following from a short position in the near term, a subsequent long position in CME’s Japanese Yen futures will allow the investor to gain from the strengthening JPY.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/
DISCLAIMER
Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
This material has been published for general education and circulation only. It does not offer or solicit to buy or sell and does not address specific investment or risk management objectives, financial situation, or needs of any person.
Advice should be sought from a financial advisor regarding the suitability of any investment or risk management product before investing or adopting any investment or hedging strategies. Past performance is not indicative of future performance.
All examples used in this workshop are hypothetical and are used for explanation purposes only. Contents in this material is not investment advice and/or may or may not be the results of actual market experience.
Mint Finance does not endorse or shall not be liable for the content of information provided by third parties. Use of and/or reliance on such information is entirely at the reader’s own risk.
These materials are not intended for distribution to, or for use by or to be acted on by any person or entity located in any jurisdiction where such distribution, use or action would be contrary to applicable laws or regulations or would subject Mint Finance to any registration or licensing requirement.
Kuroda left the YCC unchanged. Analysts expected him to scrap the YCC so that the new incoming governor, Kazuo Ueda could start afresh. Hopes of change are now expected at the next BOJ policy meeting on April 27th.
Kuroda leaves behind a mixed legacy. His strong monetary stimulus lifted the Japanese economy out of deflation at the cost of hurting bank profits with ultra-low rates. Growth has remained tepid.
Kuroda has been a source of stability. More than what was needed in the staid land of the rising sun. Now, the monetary policy landscape is expected to shift as Ueda takes charge.
New BOJ leadership and an aggressive US Fed will create near term weakness in JPY followed by medium term strength.
This case study analyses a two staged positioning in CME Japanese Yen Futures to harness yield from anticipated currency moves.
Change of Guard at the BOJ
Under the new governor, definitive shifts are afoot. Inflation in Japan is non-negative. Really? Yes. Not only non-negative but also at levels unseen in 43 years.
Kuroda may not have radically transformed Japanese economy, but he managed to revive its equity market. The risk of uncertainty and volatility exists once he leaves the office.
Markets are used to perennial Japanese low inflation, and to a consistent central bank leadership. Both are now going or gone.
Another big shift is BOJ's more definitive independence. While separate from Government of Japan, BOJ was seen as being an integral part of Abenomics to snap out of deflation. The Kishida-Ueda relationship is different.
Prime Minister Kishida has not outlined a particular direction on macroeconomic policy. Politically, the LDP is far from united, not least on fiscal and monetary policies. Kishida’s base of support within the party is fragile, and his approval ratings have been in a prolonged slump.
As a BOJ governor, Ueda comes from an unconventional background. He is the first academic to assume leadership of BOJ. He has not managed a large organization. He is knowledgeable about monetary policy and is a protege of Stanley Fisher.
What, then, can we expect from Ueda? He is not convinced that inflation is sticky. Ueda maintains that “…inflation is led by cost-push factors” and “it will still take time to achieve sustainable inflation.” It does hint that he isn't someone who will make any sudden major moves.
That said, in a parliamentary hearing earlier this month, Ueda hinted that the current YCC was unlikely to survive. Engaging the market is essential he said before adding that “in some cases, adding a surprise factor is unavoidable.”
There is growing evidence emerging from the annual “shunto” (a big wage negotiation between unions and employers) that workers are asking for the largest raise in base pay in 25 years.
Some Japanese employers have already raised wages sharply higher with case in point being Fast Retailing (a Japanese listed firm and parent company of Uniqlo) which raised pay by 40% earlier this year.
Until now, it has been possible to attribute Japan’s inflation to the rise in the cost of imports driven by weak yen. Big wage increases would change that.
However, the latest data, published Tuesday, shows that wage growth is not rising as fast as expected. In cash terms, it reached the highest level in decades last year, but the January figure was far lower. Real wages adjusted for inflation have been falling the most since 2009.
Balancing growth while keeping inflation under control is not a small feat.
Next BOJ policy meeting is more than a month away. Meanwhile, the US Fed is becoming more hawkish in its fight against domestic inflation. Another rate hike by the US Fed will further weaken the fragile Yen.
The US macro environment is making an already complicated situation even more difficult. The failure of Silicon Valley Bank along with closure of Signature Bank and Silvergate Bank is testing the Fed’s wit. US Inflation continues to remain hot and three times the Fed’s target. With the liquidity backstop in place, the Fed is likely to jack up its rate by another 25 basis points when it meets on March 22nd. CME’s FedWatch tool pegs the likelihood of that happening at 82% as of March 14th.
Against that backdrop, Ueda could do one of the three once in office – (1) further widen the 10-year JGB interest rate band, (2) target shorter term yields & thereby reduce JGB holdings, and (3) abandon yield targeting altogether.
Options Markets are Bullish JPY/USD
Options on CME’s Japanese Yen futures have an overall Put/Call ratio of 0.56 across all expiries, indicating that investors are expecting the Yen to weaken.
In sharp contrast though, options for the July contract show a deviation from the trend with a Put/Call ratio of 2.6x. This coincides with the release of the 2nd Outlook Report by the BOJ after Ueda takes over, indicating the market expectation on Yen’s reversal versus USD starting July.
How much more JGB can BOJ keep buying to sustain YCC? Can this last?
Last December, the BOJ tweaked its YCC policy, to allow the 10-year Japanese Government Bonds (JGB) yield to move 50 basis points (bps) on either side of its 0% target, wider than the previous 25 bps band. The move stunned markets as BOJ hinted at monetary tightening after having stuck to its ultra-loose policy stance for a long time.
YCC tweak spilled over into January as BOJ was forced to purchase a record 182B of JGB to defend its higher yield cap from breaching the ceiling of 0.50%. The BOJ now holds more than 50% of JGB, making the situation ever more unsustainable. Adding to the JGB burden, BOJ also owns the majority of domestically listed exchange traded funds (ETFs).
Besides massive JGB purchases, the BOJ remodeled in January a funds-supply operation into a tool to prevent yields from rising rapidly.
Beyond the current short-term loans, the BOJ amended the rules to offer funds extending up to 10 years with variable rates. In January, BOJ provided loans of 3T Yen in the January offer before extending the terms of the loan to 10-year for subsequent loans. In February, BOJ tweaked the fund-supply policy terms, including the quadrupling of minimum lending fee from 0.25%-1%, to limit the short-selling of JGB’s, this indicates that the BOJ is having to use all tools at their disposal in order to defend JGB yields from rising above their defined cap.
The BOJ defended yet another attack on the YCC again in February prompting a further 2.2B of JGB purchases to keep yields from breaching the ceiling.
Economists anticipate that Ueda will fundamentally revisit YCC before BOJ lands in crisis.
Ueda starts on April 9th. It is unlikely that he will make any radical moves instantly.
Meanwhile, Fed Chair Powell is going all guns blazing to tame inflation down. Jobs data released last Friday showed the creation of 311,000 jobs smashing expectations of 225,000 jobs indicating a tight labor market. A strong labor market risks fueling a wage-inflation spiral, leaving the Fed with no choice but to jack up rates further.
Two Stage Trade Setup to Gain from Near Term Weakness & Medium-Term Strength
CME’s Japanese Yen Futures provides investors an exposure of 12.5 million Japanese Yen for every lot with the price quoted in USD per JPY increment. Every 0.0000005 change in JPY provides an increment of $6.25 in contract value.
With the USD expected to strengthen in the near-term, JPY will weaken until the next policy meeting on April 27th. As such a short position using CME Japanese Yen futures expiring in June (6JM2023) would provide a reward-to-risk ratio of 0.6x.
Stage 1
- Entry: 0.0075390
- Target Level: 0.0074550
- Stop Level: 0.0076670
- Profit at Target: $1,050
- Loss at Stop: $1,725
- Reward-to-Risk: 0.6x
Stage 2
Thereafter, if Ueda starts to steer Japan’s monetary policy stance differently, JPY will start to strengthen in the medium term.
Following from a short position in the near term, a subsequent long position in CME’s Japanese Yen futures will allow the investor to gain from the strengthening JPY.
- Entry: 0.0074550
- Target Level: 0.0081445
- Stop Level: 0.0072775
- Profit at Target: $8,620
- Loss at Stop: $2,220
- Reward-to-Risk: 3.88x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/
DISCLAIMER
Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
This material has been published for general education and circulation only. It does not offer or solicit to buy or sell and does not address specific investment or risk management objectives, financial situation, or needs of any person.
Advice should be sought from a financial advisor regarding the suitability of any investment or risk management product before investing or adopting any investment or hedging strategies. Past performance is not indicative of future performance.
All examples used in this workshop are hypothetical and are used for explanation purposes only. Contents in this material is not investment advice and/or may or may not be the results of actual market experience.
Mint Finance does not endorse or shall not be liable for the content of information provided by third parties. Use of and/or reliance on such information is entirely at the reader’s own risk.
These materials are not intended for distribution to, or for use by or to be acted on by any person or entity located in any jurisdiction where such distribution, use or action would be contrary to applicable laws or regulations or would subject Mint Finance to any registration or licensing requirement.
Note
The first leg of the trade setup hit its stop level at 0.0076670 on 16th March 2023. The bullish move in JPY was largely driven by a weakening USD due to ongoing banking crisis and expectations of no rate hike at the upcoming FOMC meeting on Wednesday.Note
With the first leg of the trade closed, the second leg which is a long position on JPYUSD would be entered on 16th March at 0.0076670.Note
Berkshire Hathaway Inc. has started sounding out investors about the sale of yen bonds. It is one of the biggest foreign issuers of debt in JPY.Early guidance for pricing of the three-year portion of the debt is around 70 basis points over mid-swapsas reported on Bloomberg.
Warren Buffet led firm is cosnidering the sale as Kazuo Ueda takes the helm at the Bank of Japan. During his confirmation, Ueda said monetary easing needs to be in place.
While Ueda could still leave everything unchanged for a while, in a sign of traders guarding themselves against potential adjustments, Japan’s 10-year bond yields have climbed up.
bloomberg.com/news/articles/2023-04-10/berkshire-hathaway-sounds-out-investors-on-yen-bond-pricing
Note
At Kazuo Uoda's first monetary policy meeting as governor on Friday, the BoJ decided to keep policy unchanged and continued with ultra-low rate regime. The BoJ also made no change to the YCC.However, the BoJ has started a review of past policy moves and changed guidance to potentially start raising rates in the future.
As stated in our paper, it is likely that Ueda will only start to make larger policy changes at later meetings. The revised guidance suggests gives the BoJ more leeway to raise rates in case inflation rises. This pivot will act as a bullish driver for the JPY.
reuters.com/mark...-meeting-2023-04-27/
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