FxWirepro: BoJ Maintains Status Quo, Key Driving Forces And Hedging Perspectives

Today, the Bank of Japan’s (BoJ) fire power is limited - at least as far as government bond purchases are concerned. Someone who already owns the majority of Japanese government bonds (JGBs) is in a difficult position to threaten that they will be buying lots more. 

Why it is so clearly foreseeable that the limit has been reached? Because the BoJ has been buying fewer and fewer JGBs (refer 1st chart). 

Why? The JGBs tend to be yielding below the BoJ target of zero rather than above it anyway (refer 1stchart). Just as with the (short term) key rate that cannot be lowered any further due to the requirement of profitability / stability of the banking sector an inverted yield curve also has to be avoided. 

Following decades of expansionary monetary policy the banking system is so battered that it is impossible to extract more from it, regardless of how much the BoJ rambles on about "QQE" ("Quantitative and Qualitative Easing") in its statement.

The extreme volatility in USDJPY through March has given way to a narrower trading range into early April, with the pair almost flat through the past month. On a trade-weighted basis, the JPY NEER is up around 6% since China’s confirmation of human-to- human transmission of the COVID-19 in mid-January, broadly matching dollar strength (refer 2nd chart). But the large swings in USDJPY that had allowed the pair to effectively decouple from UST-JGB yield spreads look to be abating in line with the slower global spread of COVID-19 and subsequent easing in the acute uncertainty that had dominated markets through March (refer 3rd & 4th chart). 

Bullish USDJPY Scenarios, forecasts upto 100 if: 

1) COVID-19 fears re-intensify significantly, leading to multiple waves of infections or Japan-specific rises in case numbers; 

2) Assessments for the prospect of a V- shaped global growth recovery are significantly tested; 

3) Trade tensions between the US and China re-intensify with negative spill-overs to Japan’s supply chain.

Bearish USDJPY Scenarios, forecasts upto 120 if:

1) The outlook for the global economy recovers more sharply than expected and risk sentiment firms; 

2) Momentum in JPY selling flows related to outward portfolio investments and FDI repeats on a similar exceptionally large scale as seen in 1Q’20. 

When USDJPY was at 107.120 levels, we advocated buying a 2M/2w 108.910/102 put spread (vols 8.95 vs 8.55 choice), we would like to maintain the ITM long leg with the diagonal tenors on hedging grounds. The strategy has been functioning as per our expectations so far, contemplating all the above fundamental factors, at spot reference: 107.086 (while articulating) we wish to uphold the same options positions with an objective of arresting potential downside risks.

Alternatively, shorting USDJPY futures contracts of mid-month tenors have been advocated, on hedging grounds, we upheld the same positions, as the underlying spot FX likely to target southwards up to 105 levels in the medium run. Courtesy: JPM & Commerzbank