Rabobank’s FX Strategy team says the Bank of Japan’s gradual rate-hike approach reflects a run of exceptional shocks, including tariffs, war and domestic political change. Governor Kazuo Ueda has tied further tightening to improving activity and prices, while pointing to firmer wage-setting behaviour as a driver of underlying CPI inflation towards the 2% target. In a Christmas Day speech last year, he said the BoJ would continue to raise the policy interest rate and adjust the degree of monetary accommodation.
Ueda has also described higher oil prices as a temporary drag, though he has cited the use of government strategic oil reserves and AI-related demand as partial offsets. Together, these forces have left exports and production broadly flat despite higher energy costs and US tariff uncertainty. Separately, the BoJ has been tapering its bond-buying programme since 2024 and shrinking its balance sheet, which has sharpened attention on fiscal risks, JGB supply and the Prime Minister’s expansionary reputation, prompting calls for more government reassurance on how the budget will affect JGBs.
Bond Market Volatility and Fiscal Risks
We are seeing a critical transition in Japan as the Bank of Japan’s tapering program, which successfully halved monthly government bond purchases to approximately 3 trillion yen in early 2026, is now fully exposed to market forces. This reduction in central bank buying has left investors highly sensitive to Japan’s massive public debt, which remains above 260% of GDP. We believe derivative traders must prepare for heightened volatility in Japanese Government Bonds (JGBs) as domestic fiscal risks take center stage in the coming weeks.
With policy rates hovering around 0.50% and inflation consistently tracking near the 2% target, the pressure for further monetary tightening is mounting. We suggest FX derivative traders utilize USD/JPY put options to capture potential gains from a strengthening yen as the interest rate gap with the U.S. continues to shrink. Historical shifts show how sensitive this pair is, such as when USD/JPY tumbled from over 161 in July 2024 to the mid-140s on rate hike expectations, highlighting the profit potential of well-timed downside protection.
Because the central bank is no longer absorbing JGB supply at previous levels, the 10-year JGB yield is increasingly vulnerable to upward spikes. We advise interest rate traders to position for a steeper yield curve by shorting JGB futures or paying fixed rates in yen interest rate swaps. This positioning directly capitalizes on the market’s demand for a higher risk premium to fund Japan’s expansionary national budget.
Export Resilience and Equity Market Opportunities
At the same time, Japan’s export sector is proving resilient, as global demand for artificial intelligence infrastructure offsets the negative impact of high energy prices. We recommend utilizing Nikkei 225 call options to gain exposure to technology-driven growth, which is keeping Japanese equity markets buoyant despite rising borrowing costs. This underlying economic strength gives the central bank the necessary leeway to continue raising rates without choking off economic expansion.
