AS GLOBAL fund managers and other investors gird for the Bank of Japan’s stated gradual exit from ultra-easy policy settings, they are short-selling the shortest tenor government bonds and positioning for an even weaker yen.
Since ending its unorthodox negative interest rates policy in March, the Bank of Japan (BOJ) has left markets guessing on further policy tightening.
It dropped more definite hints after a policy review last week, pledging to gradually reduce its massive purchases of Japanese government bonds (JGBs) over the next two years and possibly raise rates as early as July.
Investors adjusting their Japan books are factoring in an uncertain and glacial pace of quantitative tightening, the cost of staying short JGBs for a while and the fact that Japanese yields are far lower than those in other markets, even after accounting for possible rate rises.
Martin Harvey, London-based fixed income portfolio manager at Wellington Management, is betting on a rise mostly in short-term yields, leading to a flatter JGB yield curve.
“The yield on the 30-year JGBs is getting close to levels not seen since pre-2008, so it’s already corrected a long way up,” he said, pointing to how the BOJ has already cut down its buying of longer-dated bonds.
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“Also, if you see a more aggressive move in the front-end because the BOJ is raising rates more quickly, this should also support a flatter curve.”
Tadashi Kakuchi, executive vice-president and portfolio manager with PIMCO in Tokyo, is short JGBs in tenors up to 10 years as he believes longer-end yields are suitably priced, partly because the BOJ has been buying less of those tenors.
Shorting involves selling borrowed assets in the hope of buying them back at a lower price and pocketing the difference.
Bonds with longer-end yields are “the least affected by BOJ policy, perhaps, so this is going to be the area that is safer than the five-year or 10-year point,” Kakuchi said.
As part of its qualitative and quantitative easing aimed at ending decades of deflation, the BOJ has been a regular buyer of JGBs, so much so that it now holds nearly half of the 1,221.7 trillion yen (S$10.5 trillion) of outstanding government bonds and bills.
That policy precipitated the yen’s near 11 per cent decline versus the US dollar this year, and also against most other currencies whose yields have been rising and close to peaking.
But it has done a little less buying this year, notably paring two-year bond holdings. About 86% of its holdings are in five-year, 10-year and 20-year bonds.
Bond prices have adjusted down and yields have risen accordingly, with two-year yields up 23 basis points this year, versus 33 bps for 10-year bonds which are now at 0.95 per cent.
Sell the yen
Foreign investors have been withdrawing from the short end of JGBs, selling approximately 1.14 trillion yen worth in the week to June 14, the biggest amount in about a month.
Shun Hong Liu, chief investment officer of macro hedge fund Hong Investment Advisors, said his fund was neutral on JGBs until recently, but now holds a short position.
Shorting JGBs is however a gamble on BOJ hawkishness that not everyone is willing to stomach, not merely because they need to bet on yields rising fast enough to offset the costs of being short.
Masanari Takada, Japan quantitative and derivatives strategist at JP Morgan, said short positions by macro funds in JGB-related assets such as swaps and futures are stretched to the 99th percentile of levels since 2005, levels not seen in 20 years.
That is a risk, he said, because the “BOJ seems ambiguous and could be less hawkish than macro funds had expected.”
Some investors find it easier to trade the policy tilt by short-selling the yen, as they have been doing for months as part of carry trades involving borrowing the cheap yen to invest in higher-yielding markets.
“Interest rate differentials versus some higher carry currencies remain significant” despite the BOJ’s hawkishness, said Gautam Samarth, a multi-asset fund manager at M&G Investments.
“While the team’s predisposition would be to lean short of JGBs at current levels, the short yen trade is viewed as a cleaner way to gain exposure, given the interrelated nature of the trades.” REUTERS
