Japanese inflation is currently above 3%, with all key measures surpassing the Bank of Japan’s 2% target. The headline Consumer Price Index (CPI) is at 3.3% year-on-year, while core CPI, which excludes fresh food, is also at 3.3%. The core-core CPI, which excludes fresh food and energy, stands at 3.4% year-on-year. There is talk that the Bank of Japan may raise its inflation forecasts during its meeting on July 30 and 31. This speculation is likely backed by persistent high inflation numbers. It seems the Bank is considering updating its forecasts to better align with the current situation.

Election Impact on Economic Policy

The rising cost of living is a major concern and could affect the ruling party in the upcoming election. This Sunday, Japan will hold upper-house elections for 124 out of 248 seats, serving as a mid-term review for Prime Minister Shigeru Ishiba’s coalition. The Liberal Democratic Party (LDP) is expected to lose its upper house majority, indicating possible political instability after prior losses. This minority government faces challenges from economic pressures, including inflation, rising living costs, and potential U.S. trade tariffs. With inflation consistently above the central bank’s target, we anticipate a shift towards a more aggressive monetary policy. We believe it’s wise to pursue strategies that take advantage of a strengthening Japanese Yen. We are considering buying call options on the JPY or selling futures on currency pairs like USD/JPY. Recent market data supports our perspective, with overnight index swaps indicating about a 70% chance of a rate hike at the upcoming meeting. Additionally, the yield on Japan’s 10-year government bonds has exceeded 1.0%, a level not seen in over ten years. This activity in the bond market shows that investors are preparing for tighter monetary measures.

Strategy Implications for Investors

We expect that a stronger currency and higher borrowing costs will impact the earnings of Japanese firms, especially major exporters. Thus, buying put options on the Nikkei 225 index is a smart strategy to hedge against or profit from a possible stock market decline. We plan to time this trade around the policy announcement at the end of July. Historically, when the monetary authority made unexpected changes to its yield curve control policy in 2022 and 2023, the yen strengthened sharply. Each adjustment led to quick, strong reactions in currency and equity markets. This past performance supports our expectation of a similar response to formal policy tightening. The upper-house election adds a layer of volatility, as a poor performance from Ishiba’s party could lead to political uncertainty. This situation is ideal for options strategies like straddles or strangles on key indices or currency pairs. These trades can benefit from significant price movements in either direction, protecting us from the outcome of the election or the policy meeting. Create your live VT Markets account and start trading now.

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