BOJ Fails to Crush Big Short as UBS, Schroders See Capitulation

(Bloomberg) — Global funds will pressure the Bank of Japan until it capitulates and tightens policy, after the central bank disappointed bond bears by refusing to lift its ceiling on sovereign yields.

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UBS Asset Management and Schroders Plc are sticking with bets Japanese government bond yields will rise on the expectation the BOJ will eventually stop capping the 10-year benchmark at 0.5%, even after it kept the so-called curve control policy unchanged Wednesday. Torica Capital Pty also expects the central bank to fall in line and shift toward the global trend of raising rates.

“We see no reason to square up shorts,” said Tom Nash, a money manager at UBS in Sydney, referring to his reluctance to close out bearish bets on Japanese bonds. “The yield-curve-control policy is not consistent with the current economic and political landscape and will need to be dismantled.”

It’s been a long game for those betting against the BOJ’s policy stance as Governor Haruhiko Kuroda’s determination to stand pat for years left investors nursing heavy losses. While some of the wagers finally paid off in December when the central bank tweaked policy and yields rose, market players are now confronted with the tricky task of trying to gauge the timing of the next move.

Kuroda and his BOJ colleagues kept their main policy settings unchanged Wednesday, leaving the key interest rate at minus 0.1% and the target for 10-year yields under the curve-control program around 0%. The decision surprised investors who were positioning for a change and sparked the biggest rally in Japanese bonds in a decade.

The central bank also deployed a measure that some said could almost be taken as a doubling down on the easing stance: policy makers will decide on the interest rate for certain loans to commercial banks. Until now, these loans have essentially provided free money to banks for up to 10 years that they can use to buy bonds, thereby helping the BOJ keep yields down.

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Bowing to market pressure would “erode their credibility at a time they need it the most,” said Omar Slim, co-head of Asia ex-Japan fixed income at PineBridge Investments in Singapore. “The mother of all pivots is under way, but it will come in phases.”

The BOJ is the last central bank with negative rates and yield-curve control, which makes it vulnerable to macro funds looking for the next big trade.

Little to Lose

Some funds say pressure on the BOJ will intensify as market functionality deteriorates. Investors have little to lose by shorting Japanese debt as the BOJ will allow yields to rise gradually as part of a move to normalize policy, said Raymond Lee, chief investment officer at Torica in Sydney.

Kellie Wood, a money manager at Schroders, says Japan’s policy makers will have to capitulate at some point, given that higher yields will be at odds with their intention to maintain policy accommodation or market stability.

Read More: BOJ Jolts Financial Markets But Risk of a Bigger Shock Remains

“This is the reason why we believe the BOJ will follow the path of the Reserve Bank of Australia — ultimately removing yield-curve control as the market continues to pressure yields higher alongside persistent market instability,” she said.

In the meantime, investors may look to renew speculative wagers against the yen as the BOJ’s decision to stand pat risks weakening the currency. The yen has strengthened over 18% against the dollar since sliding to a three-decade low in October as authorities intervened and bets mounted for a slower pace of US rate hikes.

The currency largely recouped losses after dropping more than 2% versus the dollar immediately after the central bank’s announcement. However, until the BOJ relents, Japan’s currency may weaken to 135 per dollar from around 128 now, according to SAV Markets. National Australia Bank Ltd. sees the currency dropping as low as 132.

“I wouldn’t be surprised if USD/JPY makes a run at 132.50 near term,” said Richard Franulovich, head of foreign-exchange strategy at Westpac Banking Corp. in Sydney. “The next BOJ meeting isn’t until March 9, so you’re asking a lot of markets to pivot back into expectations for a BOJ policy tweak in seven weeks time.”

Read More: BOJ Outcome Seen as Setback for Yen But Bonds to Stay Pressured

While it’s unclear when the BOJ will finally pull the trigger, investors such as Blue Edge Advisors Pte’s Calvin Yeoh are banking on bearish yen bets in the short term. The hedge fund expects Japan’s central bank will maintain its tightening stance without fully ditching its yield-curve-control policy.

“The market is in a dangerous game of ‘What’s the Time Mr. Wolf?’ and we’re eight steps away thinking Kuroda will say ‘dinnertime!’” said Yeoh, a money manager whose systematic macro funds held short yen positions into the meeting. “Today was more like 5 o’clock — meaning the next tightening move is coming ever closer.”

–With assistance from Matthew Burgess and Naomi Tajitsu.

(Updates yen chart, currency level in par 13)

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