Traders face showdown with Kuroda as BOJ policy rips all assets

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The yen plummets even lower. Short sellers are pushing Japanese bond yields through the central bank’s lens. Stocks are on a roller coaster ride and credit investors are running for the backstage.

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(Bloomberg) – The yen is sinking even lower. Short sellers are pushing Japanese bond yields through the central bank’s lens. Stocks are on a roller coaster ride and credit investors are running for the backstage.

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These are some of the scenarios investors are considering as Haruhiko Kuroda stubbornly clings to ultra-low interest rates during his final nine months as governor of the Bank of Japan. His showdown with the markets looks set to intensify as runaway inflation pushes global rates higher as he tries to hold out long enough to entrench price gains in Japan.

“It all comes down to BOJ policy and yen weakness, said Amir Anvarzadeh, strategist at Asymmetric Advisors Pte, which has been following Japanese markets closely for three decades. “How the BOJ handles monetary policy and inflation will impact everything from equities to credit and provide opportunities for short JGBs – this will continue to happen until their view of rates changes.”

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In the meantime, Wall Street is aligning its bets.

Brown Brothers Harriman & Co. tips the yen past 140 against the dollar – a view shared by hedge funds and which implies the BOJ will let Japan’s yield gap with the world widen.

Still, the weaker currency could ultimately force Kuroda to cave. JPMorgan Asset Management is selling government bonds betting it will loosen its grip, letting benchmark yields rise in Japan as elsewhere.

SMBC Nikko Securities Inc. predicts more losses for equities before a rally towards the end of the year, while credit funds are reluctant to invest until volatility subsides.

short yen

Selling the yen remains one of the hottest macro trades after Kuroda sent the message at the last policy meeting in June that it was too early to cut stimulus.

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The worst-performing Group of 10 currency this year fell to 137 to the dollar last week, the lowest since 1998. Credit Suisse Group AG strategists predict a drop to 138 over the next three months while JPMorgan Chase & Co. are considering a test of 140.

“With the BOJ’s continued dovishness, we still believe the pair will eventually test the August 1998 high near 147.65,” wrote Win Thin, global head of currency strategy at Brown Brothers, based in New York, in a note.

Yet, yen fluctuations are closely tied to Treasuries and demand for the dollar. A spike in US rate hike expectations in the coming months could soothe some nerves and fears of a recession could spur a rally in safe havens, including the yen.

“If you think the Fed will be successful in fighting inflation, then the dollar peak could come as expected around the start of the year,” said Rodrigo Catril of National Australia Bank Ltd. It’s “a momentum that should see the dollar-yen trading below 130 by the end of the second half of 2022.”

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bond bear

Traders can also raise bearish bets in the country’s $9 trillion bond market.

Graticule Asset Management Asia Pte, Schroders Plc and BlueBay Asset Management are among the funds selling JGBs. Ten-year yen interest rate swaps broke through the central bank’s 0.25% line in the sand, signaling investors that they expect policymakers to be forced to capitulate.

“We are negative on JGBs,” said Arjun Vij, fund manager at JPMorgan Asset, which shorts the bonds. Investors “will continue to test the BOJ’s commitment to yield curve control, but ultimately the BOJ will only change its stance when the economic and political environment is favourable.”

Should the yen break through the 150 level and further increase underlying price growth in Japan, it could “create the conditions for sustained inflation and cause the BOJ to react,” wrote Morgan Stanley strategists, including Chetan. Ahya, in a note. The BOJ would “move quickly to change its forward guidance, adjust its YCC yield target and raise policy rates by 15 basis points at a future meeting.”

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But finding the right timing could be tricky. While inflation data for Tokyo released on Friday showed overall price increases of 2.3% in June, the increase was less than half that after removing volatile inputs for fresh food and energy.

The BOJ essentially told the market that it would not be intimidated by policy tightening and would do so on its own terms, said Prashant Newnaha, a strategist at TD Securities in Singapore. “That said, if the yen weakens amid rising foreign bond yields, we expect the market to reload on the shorts and retest the BOJ.”

BOJ’s Unchanged Bond Plan Suggests Increased Caution Against Yen

The credit conundrum

As macro funds rush to trade, credit investors are cautious as sales of Japanese corporate debt fell in June. Investors have seen some of the worst returns on yen debt since March 2020.

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Uncertainty over BOJ policy will only escalate towards the end of the year, which could dampen corporate bond sales, said Kazuma Ogino, senior credit analyst at Nomura Holdings Inc.

“Investors may sit on the sidelines for another three months or so until interest rate volatility subsides,” said Tsuyoshi Yoshikawa, senior credit analyst at SMBC Nikko. “We see the July pipeline recovering, but details regarding how many tickets these companies plan to issue are still pending.”

Stock roller coaster

Stock pickers are also bracing for turbulence.

Local equities could be hammered by declining appetite for risky assets as Federal Reserve rate hikes raise fears of a recession. The good news is that a weaker yen should bolster export earnings, which could help struggling sentiment.

Japan’s benchmark Nikkei 225 Stock Average could fluctuate between 25,000 and 30,000 in the second half as investors assess global risks, said Takatoshi Itoshima, strategist at Pictet Asset Management. It closed just above 25,900 on Friday, down nearly 10% since early January.

“The market could drop to around 25,000 as we head towards the Fed rate hike in late July,” he said. “But I expect the market to rebound and test higher, probably between September and December.”

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