Japan’s economy expanded by 0.5% quarter-on-quarter in the first quarter, outpacing the 0.3% consensus forecast. The reading points to firmer near-term momentum than expected at the start of the year.
The 0.2 percentage-point beat versus expectations may influence assessments of domestic demand and the policy outlook. Markets will watch forthcoming activity and inflation data to gauge whether the growth pulse can be sustained in the next quarter.
Stronger Growth and Policy Implications
The stronger-than-expected GDP figure for the first quarter suggests Japan’s economy has more momentum than was priced in. We see this as a clear signal that the underlying economic health is improving. This positive surprise should provide a tailwind for the Japanese yen in the near term.
We believe this data gives the Bank of Japan more justification to accelerate its monetary policy normalization. The BoJ has been cautious, but with inflation recently holding around 2.7% and now solid growth, the odds of a rate hike before the end of the third quarter have increased significantly. This potential policy shift is now our central focus.
In response, we are looking at buying JPY call options against the dollar, targeting a move below the 150 level in the USD/JPY pair. The yen has weakened considerably over the past two years, and this could be the catalyst for a reversal. We see implied volatility as being too low given the increased chance of a policy surprise from the central bank.
Market Strategies and Sector Impacts
For equities, the outlook is more complex. While a strong economy is bullish, a rapidly appreciating yen would hurt the earnings of Japan’s large exporters, which make up a significant portion of the Nikkei 225. Historically, a 1% strengthening in the yen can trim earnings per share for exporters by a similar amount.
Therefore, we are considering long positions in futures on the TOPIX index, which is more weighted towards domestic companies that benefit from a strong local economy. To hedge this, we may buy put options on the Nikkei 225. This pair trade strategy positions us to benefit from domestic growth while protecting against the currency risk faced by exporters.
We are also anticipating a rise in Japanese government bond (JGB) yields as the market prices in a more hawkish Bank of Japan. Looking at the yield curve, which has been extremely flat, we see an opportunity for steepening. We are exploring interest rate swaps to position for a rise in short-term rates over the next six months.
