The Bank of Japan has released a heavyweight signal.

On August 20, two new research reports issued by the Bank of Japan warned that the persistent inflation pressures in the Japanese economy indicate that the bank still has reason to raise interest rates again. It is worth noting that Japan's unexpected interest rate hike in late July caused the Japanese stock market to plummet, with a "Black Monday" and even a global financial market upheaval.

Currently, the market expects the Bank of Japan to suspend interest rate hikes at the September monetary policy meeting, but some institutions have said the Bank of Japan may raise interest rates again later this year or in January next year. Vanguard, the world's second-largest asset management company, is betting that the Bank of Japan may raise interest rates by another 50 basis points before December and has doubled its short position in Japanese government bonds based on this judgment.

Affected by the expected interest rate hike in Japan, the yen carry trade continues to close, pushing the yen exchange rate to continue to rise. Deutsche Bank released a research report stating that Japanese institutional investors, including insurance companies and retirement funds, have built up a huge exposure to foreign assets. If these positions begin to be closed on a large scale, it will undoubtedly have a significant positive impact on the yen.

The Bank of Japan's heavyweight signal.

On August 20, the Bank of Japan's latest two research reports released a heavyweight signal, warning that the persistent inflation pressures in the Japanese economy indicate the bank still has reason to raise interest rates again.

These two reports were compiled by officials from the Bank of Japan's economic department. One report on service prices points out that pricing behavior is changing as wage pressure intensifies. It is important to investigate whether this phenomenon will further spread through comprehensive analysis.

Another report on labor shortages emphasizes that the Japanese labor market has undergone structural changes, which may give workers more bargaining chips to demand higher wages.

The report states that after the improvement of labor market liquidity and the connection between formal and part-time employees, companies' wage-setting behavior may become more active.

After the publication of the two reports, the USD/JPY exchange rate fell from around 147 to 145.12, down 0.1% on the day.

The conclusions of these two reports serve as a reminder to the market that the option of raising interest rates is still under consideration by the Bank of Japan.

It is reported that Bank of Japan Governor Haruhiko Kuroda will attend a hearing in the Japanese parliament on Friday to elaborate on the ideas behind the interest rate hike at the end of July and discuss inflation prospects.

On July 31, Haruhiko Kuroda suddenly announced a 15 basis point interest rate hike, raising the Japanese policy rate to 0.25%. This action became a "Black Swan" event in the market, causing the yen to soar continuously and the Japanese stock market to experience a "Black Monday".

Subsequently, Bank of Japan Deputy Governor Masayoshi Amamiya released a "dovish" signal to pacify the market, saying that the Bank of Japan would not raise interest rates when the market was unstable. This made market participants suspect whether the Bank of Japan still has the possibility of raising interest rates this year.

Taro Kimura, an economist at Bloomberg Economics, said not to view Masayoshi Amamiya's remarks as a signal that the Bank of Japan has turned "dovish," because he emphasized that the policy rate is "very low" based on its real value, and if the economy meets the Bank of Japan's forecast, the Bank of Japan will continue to adjust the policy rate.

Betting on an interest rate hike.

Currently, the market generally expects the Bank of Japan to suspend interest rate hikes at the September monetary policy meeting. However, according to a survey conducted earlier this month, most economists expect the Bank of Japan to raise interest rates again later this year or in January next year. Vanguard, the world's second-largest asset management company, is betting that the Bank of Japan may raise interest rates by another 50 basis points before December and has doubled its short position in Japanese government bonds based on this judgment.

Ales Koutny, director of international interest rates at Vanguard, believes that the Bank of Japan will need to raise interest rates more quickly than expected. After decades of fighting against price stability and decline, rising wages can continue to boost the domestic Japanese economy and open the door to at most two more interest rate hikes this year.

The latest data shows that Japan's real GDP growth rate in the second quarter of 2024 was 0.8% on a quarter-on-quarter basis, higher than the market's general expectation of 0.6%. The Japanese consumer confidence index also stabilized in the second quarter.

M&G Investment Management, a wealth management institution, also bets on the prospect of the Bank of Japan raising interest rates in the year, further increasing its short position in Japanese government bonds while also increasing its holdings of yen. Further interest rate hikes will stimulate the yen to appreciate further, and Japanese government bond yields will also continue to rise gradually.

RBC BlueBay Asset Management is also seeking to increase sales of 10-year Japanese sovereign bonds. Mark Dowding, chief investment officer of the institution, who has long been bearish on Japanese government bonds, said, "In the past few weeks, Japan's trading has cost us, but we have not been forced to close out. Data and news still support our view, and we hope to maintain patience with this position." In addition to betting on the increase in short-term Japanese government bond yields, these institutions have also begun to engage in yield curve flattening trades, buying 30-year or longer-term Japanese bonds.

The yen makes a big comeback.

After experiencing Black Monday, some active investors bought Japanese stocks on a large scale, with the buying scale reaching the largest in nearly two months. Under the continuous closing of yen arbitrage trading, hedge funds are also net-long yen for the first time in the past three years.

According to data from the Commodity Futures Trading Commission (CFTC) as of the week of August 13th, hedge funds held a net long position of 86 yen contracts, worth approximately US $7 million. This is the first net long yen position hedge funds have had in nearly three years.

Analysts pointed out that this is related to the recent large-scale closing of yen arbitrage trading.

Previously, one of the main reasons for the depreciation of the yen was yen arbitrage trading. In the low interest rate environment in Japan, a large number of traders borrowed cheap funds in Japan to purchase assets with higher returns overseas. The USD/JPY exchange rate once reached a 38-year high of 162, and the yen was extremely bearish.

Since early July, hedge funds have begun to significantly cut their short positions on the yen, causing the yen to appreciate by about 10%, outperforming other currencies of G10 countries.

Under this rising trend, a large number of yen arbitrage traders began to close out their positions.

According to a research report released by Deutsche Bank macro analyst Tim Baker, Japanese institutional investors' arbitrage trading is still in full swing. As heavyweight players with huge overseas assets, every move by Japanese institutional investors affects the nerves of the global financial market.

According to a Deutsche Bank research report, Japanese institutional investors, including insurance companies and pension funds, have built up a huge exposure to foreign assets, now accounting for 30% of their total assets with a total amount exceeding US $2 trillion. In comparison, the market value of the S&P 500 index is US $48 trillion, and the total amount of US bonds is US $25 trillion. This large exposure also makes Japan have the largest net international investment position among major economies.

Deutsche Bank believes that if these positions begin to be closed out on a large scale, it will undoubtedly have a significant positive impact on the yen. According to Deutsche Bank's estimates, this could lead to yen inflows equivalent to 8% of Japan's GDP, and could significantly improve Japan's balance of payments situation in about a year's time.

Akira Moroga, chief market strategist at Aozora Bank, said that the closing of arbitrage trading positions may continue to support the yen, so it is difficult to assume that the bearish positions on the yen will continue to increase as in the past. Panic position adjustments are expected to end, but investors will continue to try to buy yen.

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