Despite the sharp drop in market pricing for Japan's adoption of more tightening measures after the recent market downturn, some big-name investors are still betting that Japan will raise interest rates further in the coming months.

The world's second-largest asset management company, Vanguard, has doubled down on short positions of Japanese government bonds, believing that the Bank of Japan may still raise interest rates by 50 basis points before December. The prospect of another rate hike also prompted M&G Investment Management to continue increasing its short positions of Japanese government bonds while maintaining an overweight position in the Japanese yen. RBC BlueBay Asset Management continues to sell Japanese 10-year government bonds.

These positions are inconsistent with pricing in the overnight index swap market. Based on the trend of the overnight index swap market, the probability of the Bank of Japan raising interest rates from 0.25% before the end of the year is about 34%, lower than the approximately 63% at the beginning of this month. Their views are also in contrast to other institutions such as Alliance Bernstein.

Alliance Bernstein believes that the Bank of Japan will have a hard time raising interest rates further in 2024 unless the yen against the US dollar exchange rate falls above 160. However, if these three institutions are proven correct, the tightening policies may stimulate further appreciation of the yen, while Japanese government bond yields will continue to gradually rise.

Despite Bank of Japan Governor Haruhiko Kuroda's statement on July 31st that interest rates may continue to rise after that day's hike, the expectation of further tightening measures quickly slipped away. A series of weak US data triggered a sell-off of risk assets, including yen carry trades. Vice Governor Masayoshi Amamiya's suggestion that policymakers would avoid raising interest rates during market instability was seen as a dovish signal by many investors. Subsequently, the shake-up in Japan's ruling party leadership cast further shadow on the prospects of raising interest rates in the short term.

The sharp reversal of rate-hike expectations triggered a steep drop in the yield of 10-year Japanese government bonds this month. However, Mark Dowding, chief investment officer of BlueBay and a long-time bear on Japanese government bonds, is still seeking to increase his bearish bets on Japanese government bonds as he expects the Bank of Japan to raise interest rates again.

"The trade in Japanese government bonds has cost us over the past few weeks, but we haven't been forced to close positions," he said. "The data and news flow support our view. Therefore, it tells us to be patient and hold positions."

He believes that the Bank of Japan's next rate hike will be in January next year.

The view of Ales Koutny, head of global rates at Vanguard, is similar to that of BlueBay's, and he has a large short position of Japanese government bonds. The asset management company has long been bearish on Japanese government bonds, believing that the Bank of Japan needs to raise interest rates faster than expected.

Koutny said, "Some people think that Amamiya's remarks mean that the Bank of Japan will not raise interest rates again, but I think this gives the market a confidence booster."

He added that as Japan overcomes its decades-long struggle of staying flat and falling in line with the prices of goods and services, rising wages can boost the domestic economy and open the door to two more rate hikes this year.

However, Koutny also acknowledges that the Bank of Japan may postpone interest rate hikes during market instability.

As these three investment companies are betting that short-term Japanese government bond yields will rise, they have entered into curve flattening trades by buying bonds with maturities of 30 years or longer because they believe that 10-year bond yields are still too low at current levels.

M&G also maintains an overweight position in the Japanese yen. Eva Sun-Wai, M&G fund manager, said, "We believe the Bank of Japan may be more hawkish than the market hopes. I wouldn't be surprised if there is a slight rate hike again before the end of the year."

Editor/Emily