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The Bank of Japan (BoJ) surprised the market Friday by increasing its buying in 5-10 year bonds, trying to keep the 10-year JGB yields near zero. This move comes after the central bank unexpectedly skipped widely anticipated bond-buying operations in shorter maturities, which and pushed JGB yields higher.
Markets now wait to watch the decision of the BoJ at its 2-day monetary policy meeting, that is scheduled to be held on January 30-31st, the central bank likely to stay pat as per the forecasts.
The concerted surge in the dollar since the US elections has lifted many boats, including correlations between USD/JPY and USD/high-beta pairs to multi-year highs that have historically offered stiff resistance (refer above chart).
There is a soft cap on how far correlations can rise beyond this point between a low-yielding funding currency like the yen and other pro-cyclical FX, which leads us to think that the next major thematic move in USD-correlations lower will likely be led by a de-coupling of JPY-(and possibly EUR-) crosses in response to a worsening risk backdrop.
We still await a turn in realized correlations to pull the trigger on a broad swathe of cross-yen trades, but highlight the following as potential opportunities created by the extreme set-up that are monetizable at the current market:
Digital JPY calls vs. CAD and KRW as protectionism hedges.
USD/BRL/JPY correlation triangles as quasi-hedged carry trades.
