Investors Adjusting Strategies
Investors anticipating Japan’s first rate hike in almost twenty years are shifting their approach. Rather than relying solely on cash bets for a strengthening yen, they are now exploring the options market as a means of protecting themselves against any potential disappointment. With Japanese inflation consistently exceeding policymakers’ targets and Bank of Japan Governor Kazuo Ueda expressing confidence in sustainable price gains, the consensus among investors is that a rate rise will likely occur in the coming months.
BOJ Signals Phase-Out of Stimulus
The Bank of Japan recently signaled its growing conviction that the necessary conditions for phasing out its massive stimulus package are falling into place. However, during its two-day policy meeting this week, the central bank maintained its ultra-easy monetary settings. Nevertheless, the possibility of higher short-term rates raising the yen and Japanese government bond yields briefly remains.
Options As a Risk-Controlled Alternative
Against a backdrop dominated by U.S. data and the strengthening dollar, combined with a broader decline in foreign exchange volatility, investors see options as an attractive and risk-controlled method of navigating the anticipated policy shift. By paying an upfront premium, investors can bet on currency movements without risking losses beyond the premium. The decrease in three-month dollar/yen implied volatility, which measures the cost of options contracts, reflects the one-sided nature of the bullish yen bets and makes options more affordable.
Skewed Towards Yen Calls
Data from the Depository Trust and Clearing Corporation (DTCC) reveals that dollar/yen options contracts worth $1.9 billion, with expiries over the BOJ’s March meeting and strike prices between 133 and 152, were executed in the last 30 days. Another measure, the skew, depicts a preference for yen calls, indicating that options traders are wagering on the yen appreciating against the dollar. However, it’s worth noting that the skew has narrowed in recent weeks.
Short Yen Positions Decrease
According to the U.S. Commodity Futures Trading Commission, the market overall currently holds a short yen position due to the ease at which it can be borrowed at low rates and sold for income-earning assets. Yet, the net size of this position has dropped to its lowest point in over 10 months at $4.8 billion. Bond yields in Japan have also begun to rise sharply as expectations of an imminent BOJ move intensify, with the 10-year Japanese government bond (JGB) yield increasing by nearly 50 basis points since last March’s low of 0.24%.
Yen Struggles Amidst Strong U.S. Dollar
Despite the mounting expectations surrounding a shift in Japan’s monetary policy, the yen has failed to reflect these developments fully. This is primarily due to the continued dominance of the U.S. dollar, which has hindered the Japanese currency’s performance. Consequently, more investors are turning to options to capture potential opportunities. According to Hirofumi Suzuki, chief FX strategist at SMBC in Tokyo, if the BOJ does proceed with its plans, the yen is expected to appreciate by approximately five yen from its current level.