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Thursday, March 28, 2024

What If The BOJ Disappoints Tonight: How To Trade It

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

It wasn’t until a week ago that the loud calls for the Bank of Japan to do much more easing came loud and strong, because it was last Wednesday when Goldman announced it had changed its base-case scenario from one of a June easing to making “easing in April our base-case scenario, given the rising risk that business confidence has been dented by recent financial market instability and the Kumamoto earthquakes, and in view of BOJ governor Haruhiko Kuroda’s recent proactive statements on possible additional easing in response to the sharp deceleration in inflation in April.” At that moment many Wall Street sellside lemmings promptly followed in Goldman’s footsteps and likewise made April their base easing case.

Incidentally, moments ago Japan reported its latest March inflation data, according to which prices excluding fresh food slumped 0.3% from a year earlier, the biggest drop since April 2013, suggesting Japan’s deflationary black hole is once again sucking everything in and the BOJ may have no choice but to act.

It was also one week ago when Goldman proposed that what the BOJ would most likely do was neither more QE (due to collateral limitations) nor more NIRP (due to its devastating effect), but double the pace of ETF purchases:

The main issue for the BOJ, in our view, will be the means of applying additional easing. From an exchange rate perspective, the most effective means would be to widen the negative interest rate. However, financial institutions have not reacted positively to negative interest rate and we think there is a general unease among the population with respect to the policy, so we think the BOJ is unlikely to take rates deeper into negative territory at this stage.

Another option would be to increase quantitative easing by again stepping up JGB purchases (currently at the rate of 80 trillion yen per year), but the marginal effect would be minimal as the decline in the yield curve is already more than sufficient, and we think additional expansion would even risk giving the impression that the BOJ is closer to the limit of purchasing JGBs at the current pace.

By a process of elimination, we think the BOJ is most likely to ease mainly via the qualitative measure, with increasing ETF purchasing the central pillar, with a view to improving business confidence. We think the market is already factoring in an increase in annual purchasing from ¥3.3 tn to ¥5-6 tn, and we thus think the BOJ may look to slightly more than double its current figure to around ¥7 tn.

Goldman floated one more option, namely the “possibility that the BOJ may combine the expansion of ETF purchases with a cut in the interest rate of its loan support scheme.” Incidentally this is precisely the “trial balloon” which the BOJ floated via Bloomberg the next day, sending the USDJPY higher by 300 pips – the most since the announcement of QQE – and since the market reaction to that particular “leak” was so positive, it stands to reason that this a combination of rate cuts on bank loans coupled with an increase in ETF purchases is what Kuroda will announce in a few short hours.

Then, perhaps to set an even bid/ask range, earlier this week Goldman’s FX team came out with an absolutely outlandish research report, according to which the Bank of Japan would go so far as unleashing helicopter money to push the USDJPY to 130 for one simple reason: “the BoJ is already so long into ‘the reflationary trade’ that it has to continue to deliver further accommodation for the time being.

Basically, what Goldman is saying is the BOJ has to crush its currency today at all costs or risk losing even more credibility after the January NIRP fiasco.

We doubt that the BOJ will unleash helicopter money today, but it may well boost the amount of equities it purchases by doubling its ETF purchases and it certainly may cut the interest rate of its loan support scheme to benefit Japan’s banks.

Incidentally, this is what consensus looks like ahead of today’s BOJ decision due out in just a few short hours:

Of 41 respondents, 19 predict an increase in purchases of exchange-traded funds, eight expect a boost in bond buying, and eight project the BOJ will cut its negative rate.

This also means that a majority predict the BOJ will do nothing, which judging by the recent pent up market expectations of a major BOJ easing event would likely send the USDJPY plunging, which is ironic considering what Japan has already done to its monetary base and the BOJ’s balance sheet…

But if the BOJ does disappoint, and one thinks it will, how should one trade it? For the answer we go to Credit Suisse whose strategists Shahab Jalinoos and Bhaveer Shah write that they suspect there is enough upside risk in the price for USD/JPY to allow for a decent move lower if the BOJ disappoints the market, adding what we said above, namely that the market is pricing in a higher probability of action this week than the economics consensus appears to suggest.

This is how they would trade it:

  • Buy a 3 May 16 expiry 107.80 strike USD put/JPY call for ~0.185% of notional (spot ref: 111.37)
  • Both 1-wk implied vol and the risk-reversal skew bid for USD calls/JPY puts suggest market pricing in a risk of a pop higher in USD/JPY after the BOJ that is meaningful compared to historical precedent
  • A comparison with the same indicators in the 3-mo. tenor suggests risk is concentrated around BOJ decision
  • The trade would also perform if FOMC is more dovish than generally expected at its April 27 meeting
  • Risk to the trade is limited to the upfront premium
  • If BOJ were to expand the balance sheet with a domestic asset price and credit creation focus as opposed to an explicit attempt to weaken the JPY, the infrequently seen phenomenon of both a stable JPY and a stronger Nikkei could transpire

But the biggest argument for a BOJ disappointment is that with the G7 meeting in Japan in on month on 26–27 May 2016, it’s unlikely that Japanese policymakers will want to draw attention yet again to the idea that they are in the business of manipulating the JPY lower. After all the most recent G20 meeting once again confirmed that absent “disorderly moves” in the Yen, the US would frown on any attempt to dramatically manipulate its currency lower.

Unless, of course, Abe wants to send Lew and Obama a message, that if China can enjoy a weaker dollar (courtesy of its USD peg), then so should the Bank of Japan.

In any case, for those who do think the Bank of Japan will disappoint tonight, that is how to profit.

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