The Japanese yen increased following two members of the Bank of Japan dissenting and calling for a rate hike. Despite this, the USD/JPY pair remained below 147.50, indicating a limited response to the news.
The Bank of Japan decided to keep its main policy rate at 0.5%, a move anticipated by many. The dissenting members argued that the current inflation level justified an increase in rates.
Central Bank Policy Overview
The Bank of Japan is also poised to commence the sale of its holdings in Exchange-Traded Funds (ETFs) and Japanese Real Estate Investment Trusts (J-REITS).
With two dissenting votes wanting a rate hike, the Bank of Japan’s unified dovish front is clearly cracking. This is the most significant signal for us, as it increases the probability of a policy change in the near future. The market is now forced to price in a higher chance of a hike at the next meeting.
The planned sale of ETFs and J-REITs is a subtle form of quantitative tightening that will reduce liquidity. We’ve seen this movie before with other central banks; it’s a clear step towards policy normalization. Japan’s core CPI has now remained above 2.5% for six consecutive months, providing the perfect justification for these hawkish moves.
Given this shift, we should expect JPY volatility to climb from its recent lows. We saw how implied volatility spiked during the policy shifts of 2023, and the 3-month JPY volatility index has already ticked up 8% this week. This makes long volatility strategies, such as buying straddles or strangles on USD/JPY, an attractive proposition.
Market Implications
The path of least resistance for USD/JPY now appears to be downwards. While the drop to below 147.50 is modest, it likely marks the beginning of a larger move, especially when we recall the highs above 155 reached back in 2024. Traders should consider using put options to position for a stronger yen, targeting a move towards the 142-144 range over the next few weeks.
