The Japanese Yen is taking a cautious stance ahead of the upcoming LDP leadership vote. Although the Bank of Japan plans to tighten policy further, recent movements of the Yen show changes in how major economies are managing their policies. A possible concern for the Yen’s future is the country’s fiscal outlook. If the next government opts for more expansive spending, it could change how monetary policy is applied. The Bank of Japan is also easing its approach to quantitative tightening to limit market disruptions, similar to what the Bank of England is doing.

Impact of Fiscal Measures

If the government’s spending goes beyond expectations and inflation stays high, further policy changes may be necessary, impacting real interest rates. This could alter the Yen’s value. Currently, it appears that sales of the Yen are largely driven by purchases of USD/JPY. Even if fiscal and monetary policies stay the same, it might be tough to significantly increase holdings of the Japanese Yen, though it still looks appealing. The LDP leadership vote from late September has shifted market expectations. The win of a candidate advocating for more government spending confirmed worries about expansionary fiscal policy. As a result, the USD/JPY pair has broken through important resistance levels, rising past 160 and reshaping outlooks for Japan’s economy. This new fiscal approach complicates matters for the Bank of Japan. Governor Ueda has pushed for tighter policies, but the government’s nearly ¥20 trillion supplementary budget directly challenges these efforts to control inflation. Latest core CPI data for September shows inflation stubbornly at 2.9%, well above the central bank’s goal.

Increased Currency Volatility

For derivative traders, this divide between fiscal and monetary policies points to more currency volatility in the weeks ahead. One-month implied volatility for USD/JPY options has climbed back above 11%, indicating rising uncertainty. This means holding positions through regular spot trading is becoming riskier, and it may be wise to consider options strategies for protection. As many traders already hold long positions in the Yen, as noted last month, focusing on risk management is essential. Buying USD/JPY call options or setting up call spreads can provide exposure to potential Yen weakness while limiting losses. This strategy is sensible, as the Yen’s future will heavily depend on the government’s final budget and the Bank of Japan’s response. The main issue still remains the direction of real interest rates, which are now facing pressure from proposed spending increases. This situation echoes what happened in the UK in 2022, when expansionary fiscal policies led to a sharp drop in currency value and instability in the bond market. If the Japanese government’s spending suppresses real interest rates, the Yen will likely continue to struggle. Create your live VT Markets account and start trading now.

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