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(Bloomberg) -- A once-popular currency trade betting against the yen looks set to make a comeback, as Sanae Takaichi’s near-certain elevation to Japan’s premiership raises the prospect of slower interest-rate hikes.

Japan’s currency has dropped around 2% against its G-10 peers so far this week, as investors wagered that Takaichi’s pro-stimulus stance would result in a slower timeline for the Bank of Japan’s policy tightening. Delayed hikes could well tempt traders back into a strategy known as the carry trade, where they borrow the low-yielding yen and buy currencies such as the Brazilian real or Australian dollar that offer higher returns.

“The market is likely to conclude that the yen carry trade is back on” in the short term, said Jane Foley, head of foreign exchange strategy at Rabobank.

The election outcome has pushed the yen to the cusp of a six-month low against the dollar, while bonds have slumped on concern Takaichi will unleash more government spending and fan inflation. Many market players note too that she has previously criticized the BOJ’s moves to raise interest rates, and could advocate slower policy tightening if she takes office.

Etsuro Honda, who advises Takaichi on economic policies, said Monday that a move by the BOJ to raise interest rates this month would likely come too soon after the formation of Takaichi’s administration and would be better timed in December.

All that’s spurred traders to slash policy-tightening wagers — swaps now see a 22% chance of a move at the BOJ’s Oct. 30 meeting, compared to about 57% in the run-up to the leadership vote. Should the BOJ opt to go slower on increasing the nation’s 0.5% interest rate — already among the lowest in the world — it will reassure would-be carry traders that the yen will stay a cheap source of funding.

Yen Traders Caught in ‘Mass Square-Up’ Following Takaichi Win

Masayuki Nakajima, senior currency strategist at Mizuho Bank in London, is among those who see a good chance that yen selling will accelerate. The currency may well drop toward 180 per euro, after it plumbed a record low on Monday, and could also come under pressure versus other Asian currencies, according to him.

“If Takaichi continues to argue that a weak yen will not pose negative issues for Japan’s economy, and asserts her position that the BOJ should not raise rates, the carry trade could resume, and the yen could weaken broadly,” Nakajima said.

Strategists at Deutsche Bank AG said they had decided to close their bullish yen position, as “positive catalysts seem to be lacking right now, given the political surprise.”

What Bloomberg Strategists Say...

“This year’s backdrop recalls the environment of the mid-2000s, the sort of golden era of FX carry.”

Cameron Crise, Markets Live strategist

Recent weeks have been profitable for carry traders, as they benefited from low volatility right across currency markets. But yen-funded carry trades have proved particularly lucrative, Bloomberg data shows. Those who sold the yen against the Colombian peso, for instance, would have pocketed gains of more than 5% in the past month, compared with just over 3% for the Swiss franc — another popular funding currency.

One-month implied volatility in dollar-yen has fallen over 40% from the year’s high and reached the lowest level in over 12 months in September.

Traders will now listen carefully to BOJ rate-setters’ speeches in the coming weeks for any hint of a slowdown in the policy tightening path. Erik Nelson, macro strategist at Wells Fargo Bank in London, reckons the BOJ is unlikely to change course.

“The BOJ knew this election was coming and still delivered fairly resolute guidance that more hikes were coming, and soon,” Nelson said. “If it is very tepid in its hike guidance in upcoming officials’ speeches, that would embolden JPY shorts given still-attractive carry, but I’m skeptical the BOJ will change its tune that quickly.”

And investors have been hurt by yen carry trades before. The most recent example was July 2024, when the BOJ raised its benchmark rate and unveiled plans to halve bond purchases. As the yen rocketed higher, shock waves rippled across the world, hitting higher-yielding currencies and stocks.

But for now, the yen’s weakness may be enough to sustain the appeal of carry trades.

“The yen carry trade remains attractive for the time being,” Shusuke Yamada, chief Japan FX and rates strategist at BofA Securities, said in a Bloomberg TV interview. “We think dollar-yen will rise toward 155 by year end. There’s more for the market to price in, in terms of Takaichi’s policy stance.”

(Updates price move in paragraph 2 and 4; updates BOJ pricing in paragraph 6)