RBC BlueBay Bets on Yen Strength Amid Japan's Political Transition

RBC BlueBay, a subsidiary of the Royal Bank of Canada, has established a long position in the Japanese yen against the US dollar, betting on the political transition in Japan and the potential for the Bank of Japan to raise interest rates in October, which could further strengthen the yen.

Mark Dowding, the Chief Investment Officer at BlueBay, stated, "We have utilized a short position in the US dollar to establish a long position in the yen at a level slightly below 150. We believe there is a significant possibility of action in October. Therefore, as long as Kono wins the Liberal Democratic Party leadership election, now is a more favorable time to go long on the yen."

Kono Taro, the Minister of Agriculture, Forestry and Fisheries and a reformist figure, announced his candidacy for the Liberal Democratic Party leadership on Tuesday. Investors view Kono as more supportive of interest rate hikes compared to his rival, Kishi Nobuo, who is seen as favoring loose monetary and fiscal policies. The Liberal Democratic Party, the largest faction in Japan's ruling coalition, will hold its leadership election on October 4. Previously, Prime Minister Kishida Fumio decided to resign following a crushing defeat in the July general election.

BlueBay anticipates that the US dollar to Japanese yen exchange rate will drop to around 140 in the short term, with a mid-term reasonable rate close to 135. Over the past three months, the yen has been the worst-performing G10 currency against the US dollar, depreciating by 0.8%.

BlueBay's perspective contrasts sharply with that of hedge funds. As of September 2, hedge funds have increased their short positions in the yen for four consecutive weeks. Strategists from Bank of America and HSBC also predict further weakening of the yen against the US dollar.

Earlier reports suggested that despite political instability, the Bank of Japan could still raise interest rates this year. Traders have increased their bets on further policy tightening by the Bank of Japan. Overnight index swaps currently indicate a 60% probability of an interest rate hike by the Bank of Japan by the end of the year. It is expected that the Bank of Japan's policymakers will keep the benchmark interest rate unchanged at 0.5% during their policy meeting this week.

Japan's political and fiscal uncertainties have driven up the yields on ultra-long-term bonds. Earlier this month, the yield on Japan's 30-year bonds reached a historic high of 3.285%. Dowding considers this level "fundamentally attractive."

BlueBay currently holds a long position in 30-year Japanese government bonds. Dowding mentioned that if Kono wins the Liberal Democratic Party leadership election and the Bank of Japan subsequently raises interest rates, he would consider shifting to a "long position on long-term bonds," which would make him "believe that policymakers are taking the right steps" to control inflation.

The Bank of Japan is scheduled to announce its interest rate decision on Friday, while the Federal Reserve will hold its policy meeting before then. Market expectations widely anticipate a 25 basis point rate cut by the Federal Reserve.

As of the time of writing, the US dollar to Japanese yen exchange rate remains around 146.49.