A trade known as the “widow maker” for its ability to inflict enormous losses on traders has finally paid off after the Bank of Japan shocked investors with a change to the way it controls its government bond market.
Traders at firms such as BlueBay Asset Management, Neuberger Berman and hedge fund Caygan Capital have been betting that the BoJ would relax its cap on bond yields, after aggressive rate rises this year by the Federal Reserve and other major central banks left Tokyo as an outlier with its ultra-loose monetary policy. As a result, many investment houses put on a wager that Japanese bonds would fall, nudging yields higher.
“We had reached the point where that policy was no longer warranted,” said Mark Dowding, chief investment officer at BlueBay, who has been shorting Japanese government bonds since the summer. “It was a question of when, not if.”
JPMorgan Asset Management also had positioned itself for a change in the central bank’s policy, said a source familiar with the bank, and it is continuing to bet against longer-term Japanese debt, which is especially sensitive to changes in yield curve control policy.
The Japanese central bank announced on Tuesday that it would allow long-term yields to fluctuate from around minus 0.5 per cent to 0.5 per cent, from minus 0.25 per cent to 0.25 per cent previously. Japan has been keeping long-term yields pinned at low levels since 2016 and the previous range had been in place since 2021.
The move on Tuesday ignited a powerful sell-off in Japanese government bonds, with the benchmark 10-year yield soaring by the most in almost two decades, according to Refinitiv data. The 10-year yield is now 0.42 per cent, its highest since 2015.
Fredrik Repton, portfolio manager at Neuberger Berman, said the group had expected the shift in policy and as such had bet on falling Japanese bond prices and a rising yen. He added that the increase in the yield curve control cap could signal a pivot to more sweeping changes when governor Haruhiko Kuroda ends his decade-long run at the bank.
Naruhisa Nakagawa, founder of hedge fund Caygan Capital, started shorting Japanese government bonds when the yield stood at 0.25 per cent and is now betting that the 10-year yield will rise to 1 per cent, as the BoJ gradually loosens its yield curve control.
Investors began ramping up wagers against Japanese government bonds over the summer, effectively taking a view that the debt’s price would drop. For it to be successful, the BoJ had to alter its cap on bond yields and allow them to move in a wider range. It is a risky bet that failed to pay off for bond bears in 1993, 2003 and 2013 and put some out of business.
But a huge fall in the yen this year as central banks around the world raised interest rates has put the Japanese government and central bank under pressure to act and its announcement on Monday saw the yen jump more than 4 per cent against the US dollar.
For investors betting that the yen would rise while bond prices fell, it is a huge windfall.
“We were long yen . . . but we closed that position too early when they intervened, so we didn’t have the FX position on as well,” said Dowding, referring to moves beginning in September to prop up the currency. “If we had then I think we’d be in the pub by now.”
