BlueBay Bets on Yen Strength Amid Leadership Change and Potential BOJ Rate Hike

RBC-owned BlueBay Asset Management has established a long position in the Japanese yen, betting that a change in Japanese leadership and a potential interest rate hike by the Bank of Japan (BOJ) in October will push the yen higher. "We established that position by shorting the dollar, when dollar-yen was approaching 150," Mark Dowding, chief investment officer at BlueBay, said in an interview. "We do think there is a possibility, even a strong possibility, of action in October [by the BOJ]. So, as long as Koizumi (Shinjiro) is successful in the LDP leadership election, now is a more attractive time to be long yen." Investors view Japanese Agriculture Minister Shinjiro Koizumi, who formally announced his candidacy for LDP leader on Tuesday, as more supportive of rate hikes than his potential rival, Sanae Takaichi, who is seen as favoring loose monetary policy and expansionary fiscal policy. The Liberal Democratic Party (LDP), the largest party in Japan's ruling coalition, will hold a leadership election on October 4. This follows Japanese Prime Minister Yoshihide Suga's decision to resign after a crushing defeat in the July election.

BlueBay's Yen Forecast

BlueBay expects dollar-yen to move towards 140 in the short term, with a medium-term fair exchange rate closer to 135. Over the past three months, the yen has been the worst-performing G10 currency against the dollar, depreciating by 0.8%.

Contrasting Views on the Yen

BlueBay’s view contrasts with that of hedge funds. As of September 2, hedge funds had increased their net short yen positions for the fourth consecutive week. Strategists at Bank of America and HSBC also believe the yen will weaken further against the dollar. The London-based firm has added to its yen positions over the past month, citing comments from Bank of Japan Governor Kazuo Ueda and other board members suggesting that policy normalization remains on track, barring political disruption. Media reports suggest the BOJ is likely to hike rates again this year, regardless of political volatility, after which traders increased bets on a fresh round of monetary tightening by the BOJ. Overnight index swaps (OIS) are currently pricing in a roughly 60% chance of a BOJ rate hike by year-end. The market expects the BOJ to hold its benchmark interest rate steady at 0.5% at this week's policy meeting.

Japanese Debt Market

Japan’s political and fiscal uncertainty has pushed up yields on ultra-long-dated government bonds, with 30-year yields touching a record high of 3.285% earlier this month. Dowding sees this level as attractive “on an absolute yield basis.” BlueBay currently has a "long 30-year JGB, short 10-year JGB" position in its Japanese debt trading. Earlier this year, the firm closed out its short positions in long-dated Japanese government bonds. Dowding said that if Koizumi Shinjiro wins the LDP leadership election and the BOJ subsequently delivers a rate hike (which would make him “believe policymakers are doing the right thing to control inflation”), he would consider shifting to a “long long-dated JGB” strategy. The Bank of Japan is set to announce its interest rate decision on Friday, ahead of a Federal Reserve policy committee meeting where markets widely expect a 25 basis point rate cut.