The yen falls to nearly a 40-year low, fueling expectations of a rate hike; multiple investment banks predict the Bank of Japan may release a stronger hawkish signal

According to Zhihui Finance APP, as the yen/USD exchange rate has fallen to its lowest level in nearly 40 years, more and more Wall Street institutions are betting that the Bank of Japan will accelerate the pace of interest rate hikes to curb inflationary pressures and stabilize the exchange rate.

Société Générale, Natixis, and Barclays all believe that the continued weakness of the yen may prompt Bank of Japan Governor Kazuo Ueda to take a more hawkish stance on monetary policy in the coming months.

Analysts point out that concerns about Japan’s fiscal outlook, rising international oil prices, and the persistent widening of the US-Japan interest rate spread continue to pressure the yen. At the same time, yen devaluation is increasing the cost of imported goods, further intensifying domestic inflation.

Société Générale strategists Stephen Spratt and Reo Sakida noted that rising energy prices, continued yen weakness, and the faster pass-through of costs to consumers are becoming issues of increasing concern for the Bank of Japan.

Based on this assessment, the two analysts recommend shorting 5-year Japanese government bonds and going long on 30-year Japanese government bonds to bet on further flattening of the yield curve.

This week, the yield on Japan’s 40-year government bonds briefly rose to 4.01%, approaching the record high of 4.355% set in May; at the same time, the yen/USD exchange rate once fell to 163.99, the lowest level since November 1986.

Dayeon Hong, Asia-Pacific strategist at Natixis, said that as the USD/JPY exchange rate breaks above 163, the likelihood of the Bank of Japan sending a more hawkish signal at the policy meeting on July 31 is increasing.

She suggests investors take positions in 2-year yen interest rate swaps to benefit from further increases in Japanese short-term rates.

Hong also said that with changing market expectations, the Bank of Japan may raise rates faster than currently priced in by the market.

The market generally expects the Bank of Japan to keep rates unchanged at next week’s policy meeting. Just last month, the central bank raised its benchmark rate to 1%, the highest in 31 years.

The interest rate swaps market currently expects the Bank of Japan to hike rates by a cumulative 32 basis points by year-end. However, a Bloomberg survey shows that about half of economists still expect the Bank of Japan to wait until December for the next increase.

In contrast, Barclays expects the Bank of Japan’s next rate hike will come in October, followed by another increase in April next year.

Barclays analysts Naohiko Baba and Takashi Onoda said that in order to curb the continuous devaluation of the yen and buy time for the next rate hike, Kazuo Ueda is expected to send as hawkish a signal as possible at the July 31 policy meeting and subsequent press conference, including a more hawkish statement on the timing of the next hike.