Alun John and Tom Westbrook

SINGAPORE, (Reuters) – Investors have resurrected one of the worst bets of the last two decades. They are betting that a combination of price pressures and politics would lead to the impossible: a hawkish shift in the Bank of Japan. Perhaps as early as this summer.

This hint has not been given by the modern pioneer of quantitative ease. Rising inflation and an election are threatening to raise the cost of living. A falling yen has also resurrected a bond market that was dulled over years of intervention.

The BOJ started its interest rate targeting policy in 2016 and yields are now at their highest level. Traders realize there’s something to lose, so both banks face increasing pressure to keep the 10-year target.

David Beale is the head of Asia’s institutional client coverage. Deutsche Bank (DE:).

His comments indicated that bets are being placed on the volatility of rates as well as on Japan’s yield curve steepening with longer-dated yields going up. Investors believe there is a possibility that the central banks will raise their target yield or move it down to the five year tenor.

The gap between the 10-year and 30-year yields has widened to the greatest extent in over three years. Five-year bonds, on the other hand, have seen their longest selling streaks since 2008. [JP/]

It is also being watched by investors who see it as an area of concern for the BOJ.

Beale claimed that “Vol” is now moving in dollars/yen, which refers to the volatility gauges that have steadily increased since September.

Additionally, equity investors prepare their portfolios to handle currency fluctuations.

Corestrat is a private wealth management firm based in London. Kartik Ramachandran has been bullish about Japanese stocks but now looks for companies that can benefit from the weakening yen. He also keeps an eye out for policy risks.

We believe the risks are well balanced. He said that if there is a shift in the risk balance, due to higher commodity prices, weaker yens, and slow wage growth, then the BOJ would act.

WIDOWMAKER

The abrupt Australian abandonment of yield control has prompted bond traders to believe that the next few month are critical because there are two triggers: inflationary pressure, and an upper-house vote due in July.

The wholesale inflation rate is at its highest level in four decades and it’s heading towards consumers. When the report period ends, economists predict that headline inflation will spike in April because of last year’s unexpected falls in mobile phones bills.

Globally, rising yields also means that Japan’s anchored rates are impacting the yen. As this feeds into living costs and energy prices it will likely increase pressure on politicians and policymakers to address it.

Tohru Sakaki, Japan Markets Research head at J.P. Morgan Tokyo said, “The situation in Japan is completely different”

Japan will be affected by a weak yen, higher oil prices and other negative factors. This could be an opportunity to change the BOJ’s policy.

As previous attempts to create a top on the Japanese bond market that was nearly half-owned and controlled by the BOJ failed, so bets on either a change in policy or a crisis in Japan are called “widowmaker” trading.

It is not clear that the current time will be any different. However, there seems to be enough chaos in the market for a showdown.

YEN SQUEEZE

The firing line is likely already open for the yen.

The dollar is down almost 5% after trading around 114.70. According to the U.S. Commodity Futures Trading Commission, leveraged funds were the beariest on the currency in November. Speculators also increased their short yen trades.

Ian Samson of Fidelity, portfolio manager for Fidelity, said more inflation pressure or pressure on the Japanese yen would have to overcome the BOJ’s stubborn resolve. He said, “Come back once the yen has 15% less,” and that maybe then he would.

Colin Asher of Mizuho London senior economist says investors will pay more attention to the BOJ’s next policy meeting. This is in reference to 2018’s precedent, when the markets tested the 10 year bond’s outer limit and were quickly widened by the central bank.

It seems as though BOJ and market have been locked in for an extended tussle.

Shafali Sachdev from BNP Paribas’ FX in Asia (OTC) Wealth Management stated, “We… expect an increase in investors bets that dollar/yen volatile will rise to at least stay high,”.

This would correspond with the view that the market is constantly testing the BOJ on cap resolve and then having them defend it.”