In just one week, swap traders cut in half their expectations for the Bank of Japan to raise interest rates again this year.

On Thursday, swaps markets priced in only about a 30 percent chance that the Bank of Japan would raise rates by a quarter point before its December meeting, compared with more than 60 percent a week ago.

Meanwhile, the yield on two-year Japanese government bonds, which surged to 0.46% after the Bank of Japan's rate hike last week, has now fallen to 0.27%.

Following what many saw as hawkish signals from Bank of Japan Governor Kazuo Ueda last Wednesday, Deputy Governor Shinichi Uchida struck a dovish note on Wednesday, suggesting policymakers will refrain from raising rates amid market uncertainty.

"The Bank of Japan's policy stance has changed quite a bit since last week's monetary policy meeting," said Eiji Dohke, chief bond strategist at SBI Securities in Tokyo. He said the Bank of Japan could resume discussions on further rate hikes as early as December if financial markets calm down, but the yen's reaction could complicate the central bank's policy decisions.

A summary of the opinions of the Bank of Japan's July monetary policy meeting released on Thursday showed that some committee members mentioned the need to continue raising interest rates, with one saying that rates should eventually be raised to at least around 1%.

The summary, which diverges from Uchida’s comments that the BOJ may pause further rate hikes due to market volatility, underscores the delicate task facing the central bank and could unsettle investors.

While hedge funds appear to have retreated from bullish yen bets, they are still willing to hedge upside risk to the yen at a high price, suggesting they are increasingly uncertain about the yen’s next move.

In fact, options markets this week showed that safe-haven demand against sharp moves in the yen over the next month has reached its highest level since early 2023.

Some analysts believe the unwinding of the yen carry trade may have further to go and may be only halfway completed, which could add to market volatility.

Some analysts also believe that even if the Federal Reserve implements a large interest rate cut in September as most traders expect, and the Bank of Japan raises interest rates again, investors will still be motivated to re-enter the carry trade.

"There could be new yen shorts," said Jan Foley, a strategist at Rabobank. "Just as people bought the S&P 500 dip on Tuesday, they are likely to buy the dollar-yen dip as well." "There will be people who think there is no reason to expect further unwinding of the carry trade, that's the nature of the market," he said.

The article is forwarded from: Jinshi Data