Last week it seemed like everyone was oblivious to the risks around the Bank of Japan decision but now the world has tuned in and there's plenty of worry.
Tomorrow's decision has rankled the Japanese bond market and led to a big bid in the yen. Deutsche Bank is out with a note suggesting further yen strength and a positive risk backdrop if yield curve control is dropped.
"If yield curve control is suspended overnight we would expect global risk appetite to ultimately digest it positively as a major risk event will be out of the way," writes FX strategist George Saravelos, arguing that it won't be a shock.
"When the EUR/CHF peg broke in 2015 it was a very large VaR shock to the market. No one was expecting it and the market was very long EUR/CHF. This time, the market has been preparing for an end to yield curve control for nearly a year now. We would argue that the BoJ's huge JGB buying operations since December and the widening of the band are precisely aimed at de-risking the domestic market of stale JGB long positions."
Saravelos argues that the best trade is to be long JPY and not short Japanese government bonds.
"So extreme is the market's Japanese government bond underweight that it is reported that the BoJ may own more than 100% of some benchmark 10-year JGBs. Not only has the central bank bought the entire stock of bonds, it has lent it out to short-sellers who have sold it back to the BoJ... We have also emphasized that the Japanese have already sold record amounts of foreign fixed income with the liquidity currently held in dollars and foreign currencies waiting to be allocated. The bottom line is the Japanese are very underweight JGB and JPY. The next big flow of funds is therefore a repatriation of money back into JPY and deployment to fixed income. By extension, there should be persistent demand for JGB and JPY as Japanese yields start to normalize."
Adding to the case for yen strength would be the end of negative rates, something DB argues could come as soon as mid-year and that the BOJ will soon have to start about quantitative tightening.
