Bank of Japan Governor Kazuo Ueda said real interest rates are clearly negative, Reuters reported on Thursday. He said short- and medium-term interest rates are also clearly negative.
He said Japan’s financial conditions remain accommodative. He said this has led to a moderate rise in capital expenditure.
Negative Real Rates And A Weak Yen Backdrop
At the time of reporting, USD/JPY was up 0.10% on the day at 158.73.
We remember when these comments about negative real rates were made back in 2024, a time when financial conditions were extremely loose. That environment pushed the USD/JPY pair to historic highs near 160, creating a very different trading landscape than we see today. The core challenge then was navigating a persistently weak yen.
Those accommodative conditions fueled a massive and profitable yen carry trade, as the interest rate difference between the U.S. Federal Reserve and the Bank of Japan was over 5 percentage points. Traders were borrowing yen for virtually nothing and investing in higher-yielding dollar assets. This one-sided trade created momentum but also built up significant risks of a reversal.
The approach of the 160 level in USD/JPY during that period in 2024 caused extreme market nervousness and a spike in currency volatility. Options traders should recall how one-month implied volatility surged above 10% as the market braced for government action. This highlights the ongoing need to use options to manage the risk of sudden, sharp moves.
Managing Intervention Risk With Derivatives
We saw firsthand how risky shorting the yen was when the Ministry of Finance directly intervened in the market. In April and May of 2024, authorities spent approximately ¥9.8 trillion to buy yen, causing immediate and sharp drops in USD/JPY. Any derivatives strategy must account for the possibility of such official action when the currency weakens significantly.
Since that time, the Bank of Japan has officially moved away from its negative interest rate policy, starting with its first rate hike in 17 years back in March 2024. This was followed by a couple of cautious quarter-point hikes through 2025 as inflation proved stubborn, staying above the 2% target. The policy direction has fundamentally, if slowly, started to change.
In the coming weeks, traders should use derivatives to position for a continued, gradual normalization of BoJ policy, not a sudden shock. Look at interest rate swaps to bet on the timing of the next BoJ rate increase, which markets are now pricing in for the third quarter. Consequently, holding long-yen positions through call options is becoming a more viable strategy than it has been for years.
