Tokyo Financial Exchange is set to introduce a new futures contract designed to help traders hedge against increasingly volatile markets, as the country's interest rate landscape is being reshaped by more aggressive action from the Bank of Japan.

The exchange will launch this month a futures contract tied to the BOJ's uncollateralized overnight call rate, allowing traders to position themselves around interest rate movements during the central bank's policy meetings.

Tokyo Financial Exchange stated that its existing three-month TONA (Tokyo Overnight Average Rate) futures contract can no longer meet traders' hedging needs 鈥?traders require risk management tools to address changes in rate expectations triggered by each BOJ policy decision.

Last month, the BOJ raised its key policy rate for the second time this year, bringing it to 1.25%, a 31-year high; the market widely expects the central bank to hike again in December. This pace of increases is far faster than the previous cadence of roughly one hike every six months.

Ryosuke Seo, Director of the Wholesale Business Division at Tokyo Financial Exchange, said: "Recently, interest rate volatility has become more active, and demand for derivatives trading has also increased."

Although the market expects the BOJ to continue raising rates, trading volume in three-month TONA futures has declined in recent months. The exchange noted that September volume fell nearly 50% compared to the same period last year.

Tokyo Financial Exchange and the Osaka Exchange, a subsidiary of Japan Exchange Group, launched three-month TONA futures in 2023, a year before the BOJ ended its negative interest rate policy. These exchanges face competition from the much larger over-the-counter (OTC) interest rate swap market, where swaps can be customized to users' needs, including tenor.

According to data from the Japan Securities Clearing Corporation, the OIS (Overnight Index Swap) OTC market has been growing, with the notional value of yen contracts with tenors of 30 years or longer hitting a record high last month. Swap rates covering the period between two BOJ meetings are widely used to assess the likelihood of a rate hike.