BOJ deputy governor Shinichi Uchida said that the US-Japan trade agreement is a positive step and helps reduce uncertainty for Japanese businesses. This agreement will be included in the next economic outlook report. Uchida pointed out that there are still questions about how tariffs will affect the economy, with both positive and negative risks in the outlook. Even with less uncertainty for businesses, it’s important to keep an eye on potential downsides.

Upcoming BOJ Meeting

The next BOJ meeting may be particularly interesting, as it will show how these developments affect their policy. While a rate change is not expected, many are curious if the BOJ will take a more hawkish approach. Uchida’s comments suggest that negative economic risks are starting to ease. With a key trade agreement offering stability, attention may turn to Japan’s own economic data. For example, Japan’s core inflation has been over the central bank’s 2% target for more than two years, recently reaching 2.2% in April 2024. This might prompt policymakers to consider tightening. This situation opens up opportunities in yen derivatives ahead of the policy meeting. The USD/JPY exchange rate is currently near multi-decade highs around 157. If the BOJ uses hawkish language, we could see the yen appreciate sharply. We saw a similar situation in late 2022 when the central bank surprised the market with a change in policy.

Monitoring Downside Risks

The focus on reduced uncertainty suggests that implied volatility in the yen, which has been high, could fall. We think this makes strategies like selling volatility on the USD/JPY appealing, as this could be profitable if the currency pair stabilizes or if volatility expectations decrease after the meeting. However, we must also be cautious about monitoring downside risks. If the Bank of Japan stays fully dovish and disappoints those expecting a hawkish shift, the yen might weaken past its current levels. Therefore, holding some out-of-the-money USD calls against the JPY could be a smart move to hedge against a non-event. We are also keeping a close watch on Japanese Government Bond futures. Any indication of a quicker-than-expected policy normalization could lead to higher yields and lower prices for bond futures. Traders might want to prepare for this by taking short positions in JGB futures. Create your live VT Markets account and start trading now.

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