Despite growing speculation that the Bank of Japan may raise interest rates further, Legal & General Investment Management (LGIM), the UK's largest asset manager, is betting that the central bank's policy actions will fall short of market expectations.
The asset management giant expects that any intervention by Japanese authorities will not be able to support the battered yen, so it expects the yen to weaken further against the euro. It also bought 7- to 10-year Japanese government bonds and hedged them with U.S. Treasuries because it expects the Bank of Japan not to raise interest rates as much as expected.
The bets are bucking a trend. Many market participants expect the yen to strengthen and bonds to fall following the Bank of Japan’s historic move last month to raise interest rates from negative territory. Moreover, the yen stopped its slide after approaching the 152 level seen as a threshold for intervention, while Japanese bonds came under pressure.
"A lot of people think the Japanese government bond market is going to collapse," said Christopher Jeffery, head of macro strategy at LGIM, which manages about $1.5 trillion in assets. Japan's 10-year bond yield has soared from 0.56% in mid-January to around 0.79% now, with markets expecting the Bank of Japan to raise interest rates by nearly 50 basis points over the next 21 months.
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“We think that’s a pretty high bar, especially in an environment where global inflationary pressures appear to be spreading,” he said in an interview. “The removal of the Bank of Japan’s yield curve control (YCC) does not necessarily mean that interest rates will inevitably face upward pressure.”
LGIM’s bets take aim at a key theme in global markets in recent months: the extent to which central banks will adjust their policies and whether disagreements among them will present trading opportunities.
Bank of Japan Governor Kazuo Ueda this week hinted that further rate hikes are possible in the second half of this year as the likelihood of achieving the 2% inflation target will continue to rise.
However, Jeffrey believes that unless the Fed starts to cut interest rates aggressively, the high interest rate differential between the two countries will lead to continued yen weakness. He prefers to bet on a fall in the yen against the euro rather than against the dollar to avoid volatility from a change in the outlook for U.S. interest rates.
"Although the yen is currently at a dangerous level that triggers foreign exchange intervention by the authorities, it may continue to weaken," he said. "When Japanese interest rates are close to zero and US interest rates are as high as 5%, the yen's movement is not entirely 'speculative' but driven by fundamentals, and it is difficult for the Japanese authorities to stop this trend."
The article is forwarded from: Jinshi Data