Image: Reuters Berita 24 English - Investors betting that Japan would have to abandon its ultra-loose monetary policy are entering riskier ...
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| Image: Reuters |
Berita 24 English - Investors betting that Japan would have to abandon its ultra-loose monetary policy are entering riskier and more expensive territory as the battle moves to the bond market, the stronghold of the Bank of Japan.
Hedge funds and momentum chasers have benefited from the fact that Japan is currently the only major economy to enforce near-zero interest rates, which has driven up the yen's value.
Bets on future drops are being reduced as the currency sinks to levels last seen in the late 1990s, and money has moved directly in the direction of the BOJ to short the government bonds that it has pledged to support without restriction.
If the BOJ abandons its yield-curve control (YCC) policy, 10-year Japanese government bond rates might soar from current de facto cap of 0.25 percent to Goldman Sachs' estimate of fair value at roughly 0.60 percent or even higher.
However, as long as the BOJ maintains its resolve, the price may be painfully high. Its massive bond purchases have distorted a previously calm market and driven up the cost for those continuing in a business known as the "widowmaker" due to its infamously low profitability.
The BOJ purchased more bonds in June than ever before, its market control caused borrowing costs for dealers to soar to as much as 3% per week on the most popular cash bonds, and futures have become ominously volatile.
Ales Kounty, global bonds portfolio manager at Janus Henderson Investors in London, said that it "finally makes things interesting."
He noted, referring to how the value-at-risk, or the extent of the possible loss on the trade, might soar, that there are many leveraged positions and that this kind of volatility will produce a lot of VaR shocks.
The Bank of Japan has not indicated a change in policy, and last week, Governor Haruhiko Kuroda even said the bank will consider additional monetary easing measures if necessary.
No surprises are anticipated from its policy meeting the following week, as the bank reiterates its commitment to maintaining ultra-loose policy. Japanese inflation is still low by international standards, and the sluggish economy has not yet fully recovered from the pandemic.
TOURISTS
Interest rate swaps are being used by Kounty's fund to make the prediction that Japan's artificially flat yield curve would eventually steepen. Kounty claims that this approach may not always be profitable but is significantly less volatile than shorting bonds.
However, there are indications that at least some investors have begun to withdraw as a result of the recent violent fluctuations in the bond market or the scale of the BOJ purchase.
The Bank of Japan's goal 10-year cash yield has recently been marginally surpassed by the 10-year cash yield. Since the middle of June, the futures market, which has long been a favourite of short sellers, has seen a dramatic decline in turnover. [JP/]
Jimmy Lim, CEO and Chief Investment Officer at $950 million macro fund Modular Asset Management, who has reduced a short position in JGBs since June, said: "I think a lot of tourists would have gone out of it for the time being."
Value-wise, he claimed, "you're not going to have a lot of upside unless you completely abandon YCC," as the impact would be less pronounced if policymakers merely made minor adjustments.
"You're losing carry as you wait for that to happen. If it occurs somewhere in the next year, you can lose 40% of your carry, which lowers your overall income "r gain."
WHO FIRST BLINKS?
One of the pressure points putting both sides of the trade's resolution to the test is the price compression on short sellers.
Investors believe that rising inflation, which has finally reached the BOJ's 2 percent target after many years, and a declining yen are signs that the current course of action is unsustainable.
However, they are equally concerned about how the BOJ would stand up for a policy experiment it has pioneered.
According to a Deutsche Bank calculation based on BOJ statistics, the BOJ purchased a record 16.1 trillion yen ($116 billion) in JGBs last month, exceeding the Federal Reserve's monthly pace of purchases for the majority of 2020 and 2021.
This has increased its share of the bond market to above 50%, which is reducing liquidity. Some of these purchases have also brought about unanticipated strains in the futures market.
Under the condition of anonymity, a portfolio manager at a major asset management company said that if borrowing prices rise, "Bond scarcity can grow, as it has, and particular issues can become quite special."
Undoubtedly, the high JGB borrowing costs imply that there is still a significant amount of short interest.
Through a spokesperson, BlueBay Asset Management claimed that its bet on the BOJ capitulating has not changed recently and that it still retains "a short position with respect to Japanese yields."
However, given the current price levels, it might no longer be considered an all-in wager.
According to David Beale, who deals with macro funds at Deutsche Bank in Singapore, "from a hedge-fund standpoint, they still want to have something in their portfolios that will perform if the Bank of Japan alters yield-curve control at some point."
When the market is least expecting it, they will act.
($1 = 138.2900 yen)
