BOJ likely to modify policy by September: U.K. hedge fund

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TOKYO — The Bank of Japan is likely to alter its ultraloose policy between July and September as the weakening yen drives up prices and poses a political headache for the government, an executive with a U.K.-based hedge fund said in an interview with Nikkei.

Mark Dowding, chief information officer of BlueBay Asset Management, which oversees more than $120 billion and is building a sell position on Japanese government bonds, predicts the BOJ may abandon its yield-curve control strategy by the end of the year, saying that if that happens, “selling JGBs is an attractive trade.”

Edited excerpts of the interview follow.

Q: Why are overseas investors selling Japanese government bonds now?

A: We believe that, given the macroeconomic environment, the BOJ is likely to modify its current policy. The U.S. Federal Reserve is becoming more hawkish and aggressive in tightening monetary policy, which is putting upward pressure on global interest rates. In this environment, only the BOJ is trying to keep the long-term interest rate capped at 0.25%. But that is difficult to do in this environment and somewhere between July and September, the BOJ is likely to modify part of its yield-curve control (YCC) policy.

Q: But the BOJ is still saying it will continue its accommodative monetary policy.

A: We think the weak yen will make that difficult. We started selling JGB futures when the yen started falling below 130 yen to the dollar. A weakening yen will drive up prices in Japan, and that seems like a political problem.

Furthermore, the YCC has a structural problem. The more foreign central banks, such as the Federal Reserve, raise interest rates, the more the BOJ will be forced to buy JGBs — that is, take accommodative monetary action to keep the 0.25% ceiling in place. And that puts downward pressure on the yen, which will lead to inflation.

Q: The BOJ can theoretically buy an unlimited amount of JGBs. Isn’t there a possibility of losses due to higher JGB prices?

A: Of course there is a possibility that the price of JGBs will rise. That is why we have set a stop-loss level. We started selling JGBs when the long-term interest rate was around 0.21%. We will exit our positions if interest rates fall below 0.18%.

However, looking at global inflation right now, the likelihood of interest rates falling below 0.18% is quite low. On the other hand, when the BOJ moves to revise the YCC, the drop in bond prices will be very large. Furthermore, once the BOJ raises the 0.25% cap, the market is likely to continue selling JGBs in anticipation of further increases. This will weaken the yen and eventually force the BOJ to end the YCC, which, while not 100% certain, could be abandoned by the end of the year. When comparing these risks and returns, selling JGBs is an attractive trade.

  © Photographer: Robin Stanley

Q: How likely is the Finance Ministry to intervene in the currency market?

A: There is certainly that possibility. However, the BOJ buying Japanese government bonds while the ministry intervenes to buy yen would be like hitting the gas pedal and the brake at the same time, which is not a consistent policy. Investors are inclined to challenge such inconsistencies.

Q: George Soros challenged the Bank of England by selling the pound, beating the central bank. How likely is it that an investor will force Japan’s central bank to change course?

A: Some people say we are doing what Mr. Soros did, but that is not true. We are not trying to drive the BOJ into a corner, we are just trading in anticipation of a change in the BOJ’s stance. If the BOJ ends the YCC, it will be in a position to claim a victory in having managed to bring inflation in line with its 2% objective. It’s almost a measure of success.