SINGAPORE : Investors are reviving one of the most unprofitable wagers of the past two decades and betting that a combination of politics and price pressures would prompt the unthinkable: a hawkish shift at the Bank of Japan, perhaps as soon as the summertime.
The modern pioneer of quantitative easing has given no such hint. But rising inflation, an election on the horizon and a falling yen, which is driving up the cost of living, have roused a bond market dulled by years of intervention.
Yields have leapt to their highest since the BOJ began its policy of targeting interest rates in 2016, as traders figure that something has got to give, and there is mounting pressure on both sides of the central bank's targeted 10-year tenor.
"It's a binary outcome so interest in this trade from the macro community, particularly the offshore accounts, has grown since the end of last year," said David Beale, head of institutional client coverage in Asia at Deutsche Bank.
He said bets were being laid on volatility in rates and on Japan's yield curve steepening as longer-dated yields go up. Investors see a chance that the central bank lifts its target yield, or shifts it down the curve to the five-year tenor.
Price moves have opened the gap between 10-year and 30-year yields to its widest in more than three years this month, while at the shorter end five-year bonds suffered their longest selling streak since 2008. [JP/]
The currency is also in focus as investors see it as a pressure point for the BOJ and are positioning for it to slide at first, while using options to wager that things get bumpy later.
"Vol is starting to move in dollar/yen for the first time in quite some time," Beale said, referring to volatility gauges that have ticked steadily higher since September.
Equity investors are also preparing their portfolios for the possibility of currency moves.
Kartik Ramachandran, managing partner of Corestrat, a London-based private wealth manager, is bullish on Japanese stocks, but has now started looking for firms that benefit from a weaker yen and has one eye on the policy risks.
"We think the risks are balanced. Now, if the balance of risk shifts up, driven by the higher commodity prices and a weaker yen, combined with the slow and low wage growth, the BOJ will act," he said.
Emboldened by the abrupt abandonment of yield curve control in Australia, bond traders think the next few months are crucial because inflationary pressure and an upper-house election due by July are possible triggers for a policy shift.
Wholesale inflation is running near four-decade highs and heading for consumers. Economists expect headline inflation to leap in April, when last year's one-off falls in mobile phone bills start rolling out of the reporting period.
Rising yields globally also mean that anchored rates in Japan are weighing on the yen, and as that feeds further into energy prices and living costs it is likely to increase pressure on policymakers and politicians to do something about it.
"The situation is completely different from the past 20 or 30 years, so that's why people have started thinking that this time could be different," said Tohru Sasaki, head of Japan Markets Research at J.P. Morgan in Tokyo.
"Weak yen and a higher oil price are going to be very negative for Japan, so that could also be a catalyst for a change in BOJ policy."
Bets on a policy shift or debt crisis in Japan are termed "widowmaker" trades as previous attempts to call a top in the bond market almost half-owned by the BOJ have proven wrong.
There is no clear consensus that this time is any different, either, but there is enough turmoil in the market that a showdown seems to be in the offing.
The yen is perhaps already in the firing line.
Trading around 114.70 per dollar, it is already down nearly 5per cent in five months. Latest data from the U.S. Commodity Futures Trading Commission (CFTC) shows leveraged funds are the most bearish on the currency since November, while speculators have also scaled up short yen trades.
Fidelity portfolio manager Ian Samson said far more pressure on the yen or from inflation would be needed to break the BOJ's resolve. "Come back when the yen is 15per cent weaker, and then maybe," he said.
Colin Asher, senior economist Mizuho in London, says investors will pay closer attention to the BOJ's next policy meeting, pointing to the 2018 precedent when markets tried to test the 10-year bond's outer bound and the central bank responded with a quick widening of that band.
In any case it seems that both the BOJ and the market are strapping in for a prolonged tussle.
"We ... see an increase in investor bets that dollar/yen volatility will rise or at least remain high," said Shafali Sachdev, head of FX in Asia at BNP Paribas Wealth Management.
"This would be consistent with a view of the market repeatedly testing the BOJ's resolve on the cap, and having them defend it."
(Reporting by Tom Westbrook and Alun John; Additional reporting by Kevin Buckland in Tokyo and Sujata Rao-Coverley in London; Editing by Vidya Ranganathan & Shri Navaratnam)