Japan’s recent two-year bond auction saw the lowest demand since 2009. The bid-to-cover ratio hit a 15-year low. Moreover, the auction produced the largest tail since 2023. This outcome shows weak interest in short-term Japanese Government Bonds.

Expected Rate Hike Impact

The poor performance of this auction suggests that the market believes the Bank of Japan (BoJ) will raise interest rates sooner than we expected. Investors are hesitant to buy short-term bonds at current rates because they anticipate better returns soon. This belief supports our view that the era of very low rates is coming to an end. To adapt, we should prepare for a stronger yen since higher rates will attract investment. The yen has been around the 165 mark against the dollar for most of August 2025, but this auction hints at a possible change. Buying call options on the JPY or put options on the USD/JPY pair could be a smart move in the coming weeks. In the rates market, we might want to consider paying fixed on Japanese yen interest rate swaps to bet on rising short-term rates. Data from the Tokyo Financial Exchange shows that open interest in three-month Euroyen futures has increased by 12% since July 2025, indicating that more traders are hedging or speculating on a rate rise. Shorting Japanese Government Bond (JGB) futures is another way to take action.

Expected Market Volatility

This uncertainty in policy is likely to result in increased market volatility. Looking back to March 2024 when the BoJ ended its negative interest rate policy, the Nikkei Volatility Index rose over 25% in the following quarter. We can expect something similar, making long volatility positions through straddles on the Nikkei 225 index an appealing strategy. Higher borrowing costs will put pressure on Japanese stocks, especially in rate-sensitive sectors. Recent earnings from Q2 2025 already showed Japanese real estate companies facing tighter margins, a trend that is likely to continue. We should think about buying protective puts on the Nikkei 225 or specific sector ETFs to safeguard against a potential decline. Create your live VT Markets account and start trading now.

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