Image: Reuters Berita 24 English - In a battle between overseas speculators and the Bank of Japan, Japan's government bond market is bei...
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| Image: Reuters |
Berita 24 English - In a battle between overseas speculators and the Bank of Japan, Japan's government bond market is being pushed to breaking point, posing issues for loan pricing and bond sales and heightening the risk of future government funding snafus.
The Bank of Japan (BOJ) spent more than 700 billion yen ($5.2 billion) buying bonds on Wednesday to maintain its 10-year yield ceiling, only to see 10-year futures fall to their lowest levels in over a decade. [JP/]
Prices have now recovered, but liquidity remains low, the yield curve is kinked at the 10-year tenor, reducing its usefulness as a pricing benchmark, and market participants are concerned that futures may become an unsatisfactory hedge against other market risks.
"If the futures market's role is lost, that's a significant problem for (JGB) auctions - you can't really hedge your auctions... dealers will all go away," said Naka Matsuzawa, a Tokyo-based strategist.
Speculators are increasing wagers that the BOJ would alter or abandon a de-facto cap of 0.25 percent on the 10-year yield, causing the long-somnolent market to tremble.
Policymakers are under pressure because Japan is now seeing the inflation that the ultra-easy policies were intended to produce, and the yen is falling against practically every other currency as global central banks raise rates swiftly.
"The BOJ doesn't have to do anything because it has cover for not doing so," said Ian Samson, a portfolio manager at Fidelity.
"However, one quite feasible alternative is to widen the range to 0.5 percent to assist take some heat out of the yen weakness while not giving too much to the speculators."
Fidelity had initiated some short bets on the 10-year government bond early this week, assuming it was unlikely to rally significantly and might be dumped hard if policy settings changed, according to Samson.
On Friday, the BOJ wraps up a two-day meeting with no expected adjustments, but government and other sources suggest that further currency drops could prompt a response.
WEDNESDAY IN THE WOODS
The BOJ's surprise buying at the seven-year tenor was the catalyst for Wednesday's wild ride.
Market participants interpreted it as an attempt to drive shortsellers out of the futures market, because bonds with a maturity of seven years are normally delivered to close futures contracts, and driving up their price was intended to force that trade.
However, the exact opposite happened. Shorts continued to sell, and frightened dealers also sold, bringing the 10-year futures price down two full points to 145.58. Since then, the contract has recovered to 147.21.
"They have to close their holdings immediately quickly now that the function of the futures is in question," Nomura's Matsuzawa said of investors or dealers who used futures as a hedge.
The extraordinary moves have emphasised the backdrop of a market that has long been losing functionality as BOJ buying has swelled its holdings to more than 40% of the overall market.
According to data portal Asian Bonds Online, monthly turnover has consistently decreased from more than $4 trillion in 2013 to less than $3 trillion in March. Controls on the yield curve also imply that the market is losing its value as a benchmark for debt pricing and loans.
"If it doesn't work, it's going to be disastrous for the financial market as a whole," said Kentaro Koyama, a Japan economist at Deutsche Bank.
"Lower functionality could lead to fewer participation... long-term public finance stability is difficult to achieve."
The trend is unlikely to reverse until the BOJ intervenes, and the yen is under increasing downward pressure in the meanwhile.
In a note to clients, Joey Chew, a senior currency strategist at HSBC in Hong Kong, warned, "Without vocal intervention, expectations could become much more gloomy."
"In the end, actual shift in the yield gap is required for a sustained correction in the dollar/yen, and this might come from market views on the BOJ, the (Federal Reserve), or the likelihood of a recession."
(1 dollar = 134.3000 yen)
