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We hold short JPY skew risk as valuations are stretched. Short-dated tenors are exposed to BoJ under delivering this week, but longer dates offer consistently rich risk premia to fade.
JPY vol risk premia are extreme ahead of next week's BoJ meeting, with front end vols at their most elevated since Oct 2008. 1W expiries covering the BoJ are marked at a whopping 26.6, and the 1M-3M curve is at its most inverted at -2.5vols. JPY risk-reversals are also a pocket of acute stress, having steepened to multi-year highs.
Selling rich JPY skews looks compelling as the market is digesting Brexit and an uneventful Upper House election, and the attention turns to prospects of concerted balance sheet expansion and fiscal spending.
Even if the size of the fiscal package disappoints and USD/JPY resumes its grind lower on cleaner positioning, valuations, and historical back tests are supportive of short positions in JPY skews. We have previously noted the abrupt widening in JPY risk-reversals, especially leading into the Brexit, and found them to be at stretched levels.
JPY RRs have narrowed as JPY softened on chatters of “helicopter money”. Please be noted that this move, along with the pickup in USD/JPY since early July owes primarily to unwind of JPY longs and widening in USD vs JPY real rates spreads
The pairs which combine cheapest valuations and best historical returns are highlighted. We hold EUR/JPY 3M RR entered 20-Jun and picked up 1Y CAD/JPY and NZD/JPY RRs on 13-Jul. Sellers of JPY RRs will find their best prospects in EUR/JPY and CAD/JPY at the moment.
