The Bank of Japan (BoJ) is contemplating halving its pace of Japanese government bond tapering from April 2026. The monthly bond purchasing has been reduced by ¥400 billion each quarter, but a proposal suggests cutting it to ¥200 billion monthly.

During a recent session, the USD/JPY pair rose by 0.19%, trading at 144.38. The BoJ is the Japanese central bank, responsible for setting monetary policy to ensure price stability, targeting an inflation rate of around 2%.

Ultra Loose Monetary Strategy

The BoJ adopted an ultra-loose monetary strategy in 2013 to boost the economy and increase inflation. This involved Quantitative and Qualitative Easing, with measures like negative interest rates and government bond yield control.

BoJ’s stimulus measures caused the Yen to depreciate against other currencies, especially from 2022 to 2023, due to policy differences with other central banks. In 2024, as policies shifted, the Yen saw partial recovery.

The BoJ decided to unwind its policy due to rising inflation spurred by a weaker Yen and increased global energy prices, with burgeoning salaries contributing further. The central bank’s policy decisions are intended to address these inflationary pressures.

This potential adjustment in bond tapering—from ¥400 billion to ¥200 billion each month starting in April 2026—would effectively slow the drawdown of the Bank’s holdings at a more measured pace. From our perspective, this proposal reflects growing caution inside the central bank, likely prompted by a desire to maintain market stability while still stepping away from ultra-accommodative policies.

With the USD/JPY climbing 0.19% to 144.38, there’s been a measured market reaction. The exchange rate has become particularly sensitive to hints about monetary policy direction, both from Tokyo and elsewhere. Currency traders often respond first and loudest, but for us in derivatives, the moves signal something deeper: positioning is shifting, and it’s doing so in anticipation of lengthier policy transitions.

The central bank has kept to the same inflation target of around 2%, but their methods to get there haven’t remained static. Since the launch of large-scale easing back in 2013, including unorthodox moves like maintaining negative interest rates and tightly controlling bond yields, we’ve seen a decade-long experiment in monetary stimulus. These actions had an undeniable impact: the Yen tumbled, and with it came increased price competitiveness for Japanese goods, but also higher costs for imports.

Market Reaction To Policy Changes

Particularly between 2022 and 2023, the wide gap in approaches between Japan’s central bank and others such as the Federal Reserve made the Yen unmistakably weaker. As markets recalibrated in 2024, reactionary shifts began to unfold—though the recovery of the Yen has been limited and unstable.

That said, the recent pivot can’t be separated from the broader environment. We’ve seen inflation tick higher not just because of imported energy costs but also from improving domestic wages. With stronger pay packets in many industries, there’s now more pressure on prices from within. The central bank’s approach—beginning to step away from prolonged easing—should be read as a reaction not just to global dynamics but to local shifts in labour and consumption patterns.

For us traders, what’s relevant in the short term isn’t just the bond tapering slowdown itself, but what it implies. A slower reduction hints at a deliberate attempt to avoid startling markets, or sending bond yields jerkily higher. That could translate to smaller, more predictable intraday moves in rates and FX instruments—potentially offering attractive setups for interest rate swap strategies and tighter hedging timelines over the next couple of quarters.

The recent rise of the USD/JPY pair also suggests that markets may be reassessing rate differentials and the pace at which other central banks may ease in comparison to Tokyo. This environment lends itself to volatility at junctions of new data or guidance, especially when payroll numbers or price indices appear. We’d do well to keep rolling correlations front-of-mind.

The return of inflation is no longer just a concept—it has materialised, and monetary authorities are changing course accordingly. As tapering slows rather than stops, volatility in long-end rates may remain muted, while short-term instruments could see sharper sensitivities to data surprises. We may wish to adjust our spreads accordingly.

Shorter duration positions might benefit from narrowing windows of uncertainty as policy becomes more communicative. Yet, any movement in Tokyo carries potential spillover to other central bank trajectories, particularly in currencies where carry trades remain active. Therefore, scenario modelling should incorporate the possibility of benchmark realignments or FX intervention, even if indirect.

As policy nuance solidifies and zero-rate conditions fade, structural shifts can happen in curve steepness and cross-asset relationships. We suggest preparing for rotations in asset preference across time frames. Forward-looking pricing already displays asymmetry in risk perceptions, and small policy tweaks like these could well be the preamble to wider repositioning.

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