Yen, Japanese bonds, and Japanese stocks are waiting for guidance: Hedge funds are hunting the Bank of Japan's stance.

More and more hedge funds are positioning themselves for a hawkish signal that may be released by the Bank of Japan, as the escalation of the Middle East conflict has intensified the inflation risks faced by this energy-importing country. Although traders are almost certain that the Bank of Japan will choose to keep interest rates unchanged at this Thursday's policy meeting, there are more variables in the comments of Bank of Japan Governor Haruhiko Kuroda at the post-meeting press conference. This could bring even greater volatility to the already volatile yen, Japanese stocks, and Japanese bond markets. Fivestar Asset Management in Tokyo is selling 10-year Japanese government bond futures, while hedging these positions by partially taking long positions in 30-year Japanese government bonds as Brent crude oil prices hover above $100 per barrel. Blue Edge Advisors has closed out short positions on the yen amid escalating tensions in the Hormuz Strait and is waiting for an opportunity to buy. A hedge fund strategy by Pictet Asset Management continues to bet on Japanese bank stocks outperforming the market. Hideo Shimomura, Senior Portfolio Manager at Fivestar, stated, "The surge in oil prices has raised uncertainty about whether inflation expectations can remain stable. This means that the Bank of Japan has flexibility and could raise interest rates at each meeting." With the oil price shock triggered by the Middle East conflict, and concerns about borrowing costs and debt intensifying due to the expansionary fiscal stance of Japanese Prime Minister Taro Aso, traders are looking for new signals to trade Japanese assets. Investors are currently discussing whether the Bank of Japan is more inclined to address inflation risks or take a more cautious stance to support economic growth. If the Bank of Japan leans hawkish, it could boost the yen and push up Japanese bond yields; if it leans dovish, it could soften the yen while depressing Japanese yields, making assets more prone to larger fluctuations. In recent months, the yen has caused anxiety among investors, with the yen falling to 159.75 yen to the dollar at one point this week, nearing its weakest level since July 2024. Finance Minister Koichi Kato reiterated on Tuesday that authorities may take action to intervene if the exchange rate deviates from fundamentals. Calvin Yeoh, who manages the Merlion fund under Blue Edge Advisors, stated, "Global investors are still inclined to 'short Japanese government bonds, short the yen', but at current exchange rate levels, the risk of intervention is becoming more real." "If the Bank of Japan is not hawkish enough, I will look for buying opportunities." One focal point that investors will be watching on Thursday is whether the Middle East conflict has made the Bank of Japan cautious enough to rule out the possibility of a rate hike at the next meeting in April. If the Bank of Japan's description of uncertainty or risks in its statement is strong, it could signal a decreasing likelihood of taking action next month. The derivatives market shows a 55% probability of a 25 basis point rate hike by the Bank of Japan in April, with July being the first time fully priced in by the market. Strategist David Savage stated, "The Bank of Japan's hawkish stance could benefit the yen, but it could also stimulate an increase in Japanese bond yields along the entire curve." Simplex Asset Management believes that with continued price pressures, Japanese government bond yields still have room to rise in the short term. However, as the yield on 10-year Japanese bonds approaches highs not seen since the 1990s, these assets have become attractiveparticularly when funds suddenly flow into the bond market due to concerns about economic downturn. Portfolio Manager Toshinobu Chiba stated, "In the short term, cost-driven inflation risks outweigh safe-haven factors, so yields may still have room to rise. However, the market will gradually begin to factor in the risk of a global economic slowdown." He added that he had bought 10-year Japanese government bond futures and 5-year bonds before the policy meeting. Stock bets At the same time, speculative stock traders are closely watching the signals from Kuroda, as earlier this month the Nikkei 225 index saw its largest decline since the tariff shock of April last year due to rising oil prices and increased concerns about tension in the Middle East. The one-year implied volatility of the index briefly surged to its highest level since the pandemic began, highlighting investors' expectations of greater market volatility. Go Tanuma of the Tokyo hedge fund Go Fund has taken profits on Japanese stock positions. Jon Withaar of Pictet Asset Management remains bullish on Japanese bank stocks ahead of the meeting. Jon Withaar stated, "This position is based on a longer-term logic. From a more macro perspective, wage growth, benign inflation, strong profits, and funds reallocating from the U.S. and Europe to the Japanese market are all supporting the Japanese stock market." Some expect that Kuroda may not give any clear guidance, as he needs to balance controlling inflation risks with supporting economic growth. Zuhair Khan, who manages a market-neutral fund at UBP Investments, stated, "I think Kuroda is in a bit of a dilemma. He may need to keep his statements vague, allowing the market to speculate on his true intentions." For others, avoiding Japanese market risks entirely before and after the Bank of Japan's interest rate decision is their strategy. Matthew Haupt of Wilson Asset Management believes that the evolving Middle East conflict is the bigger driver of the market at the moment, regardless of the signals that Kuroda may send in his speech on Thursday. The hedge fund manager stated, "Even if you are right about the Bank of Japan, you may make the wrong trade due to the impact of the situation in the Middle East. At this stage, I will trade Nikkei futures based on the situation in the Middle East and oil price fluctuations, rather than relying on the Bank of Japan."