The Bank of Japan has a problem. That problem is the weakness of the JPY. You can see from the index chart below that JPY weakness has been pronounced this year. 

JPY weakness

The JPY being weak is great for Japan’s export economy. A weak domestic currency means that the country's exports are better value abroad. However, for the domestic economy, it means imports are more expensive. So, Japan’s domestic import market is pressured by the weak JPY and that creates political pressure to address it. Soaring US10-year yields, JGB’s being capped, higher oil prices (Japan is a net importer of energy), and leveraged FX moves on a weak JPY have all contributed to the situation.
 

What can the BoJ do?

They have three key options. 

Firstly, they could hike rates. If they did this it would be a huge surprise and immediately send the JPY higher. STIR markets only see a 0.9% chance of a hike. 

Secondly, they could stop capping JGB’s. This is the Japanese 10-year bond which is artificially kept at a band between 0.25% and -0.25% by buying bonds. If this cap is removed the JPY can strengthen, 

Thirdly, we get some kind of ‘official’ response on how JPY strength will be managed going forward including if/how/when JPY intervention might occur

Remember that the BoJ is expected to just carry on jawboning, but that means any action will have a greater market reaction since it is unexpected.
 

The Trade

The obvious trade on any hawkish BoJ development would be EURJPY shorts as the eurozone continues to head towards a recessionary environment. 

(Click on image to enlarge)

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