Can the yen's decline prompt the Bank of Japan to "turn hawkish"? Investors have re-bet on interest rate hikes

According to the Zhitong Finance APP, investors expect the decline of the yen to force the Bank of Japan to shift to a hawkish stance, prompting them to short bonds, buy bank stocks, and prepare for an interest rate hike as early as next month. The USD/JPY exchange rate has reached 154, close to the level that could trigger intervention, which may subsequently lead to an interest rate hike. This time, investors have become more cautious and are unwilling to take too much risk. They have accumulated positions, particularly in bank stocks that will benefit from rising interest rates.

The market is closely watching, as Japan's last interest rate hike three and a half months ago amid a global wave of rate cuts has partly contributed to the chaotic surge of the yen, when yen positions were quickly liquidated, affecting global markets.

Shinji Ogawa, co-head of Japan cash equity sales at JP Morgan in Tokyo, stated, "The focus and sensitivity around the Bank of Japan seem to be much higher." "This is reflected across various asset classes, whether it's direct overnight index swaps... (or) financials, which is a sector with significantly volatile stock prices."

Traders indicate that some hedge funds are also betting on rising bond yields. Since late October, expectations for a 25 basis point rate hike in Japan in December have shifted from negligible to around 54%.

"Fast money is once again focusing on the short end of the curve," said Keita Matsumoto, head of financial institution sales and solutions at Citigroup Global Markets Japan, noting that hedge funds have accumulated a small number of short positions in recent weeks.

In the two weeks following the U.S. elections, Tokyo bank stocks have risen about 13%, while the broader market has remained flat, with export-oriented stocks performing well, particularly cyclical sectors such as industrials and machinery.

George Efstathopoulos, manager of Fidelity International's $102 million global multi-asset fund, stated, "We have been focusing on Japanese mid-cap stocks and Japanese bank stocks, which will benefit from rising wages and interest rates, respectively."

He added, "Recently, our outlook on Japanese large-cap stocks has also become more optimistic, as a weaker yen is expected to translate into better earnings prospects amid a re-acceleration of global economic growth."

The Story of the Yen

The price of the yen is a major factor influencing Japan's economic and stock market performance and may affect monetary policy through import costs, which in turn can drive up inflation.

Bank of Japan Governor Kazuo Ueda only mentioned the yen during a closely watched policy speech on Monday. Since the beginning of 2021, the yen has depreciated by more than 30% against the dollar.

However, the market believes that the continuously declining yen will force the Bank of Japan to take action sooner, especially as forex traders bet on further depreciation of the yen.

Nathan Swami, head of Asia-Pacific foreign exchange trading at Citigroup in Singapore, stated, "Given the recent performance of the yen, the Bank of Japan may need to reassess whether a tougher stance is required in future meetings."

CFTC data shows that forex speculators have been increasing their bets against the yen.

It is certain that there are not many bets in the interest rate market, as the spread of over 375 basis points between two-year U.S. and two-year Japanese rates is a strong fundamental factor for the yen's weakness, which reassures many investors Shafali Sachdev, Head of Asian Investment Services at BNP Paribas Wealth Management, stated, "Given the interest rate differentials and spread trading, many clients are eager to structurally go long on the dollar."

Nevertheless, the significant rise of the yen in August, which led to the Nikkei index experiencing its largest single-day drop since 1987, left a deep impression on investors.

Geoff Yu, a strategist at a New York bank, said, "I think the yen is as important as the Japanese fundamentals." Citigroup's Matsumoto mentioned that if the yen no longer erodes dollar returns, it could even benefit foreign investors in Japan.

He said, "Because global investors have to worry about where the yen's depreciation might stop. So they are looking for the bottom of the yen."