(Bloomberg) -- With the Bank of Japan holding firm on its policy of yield-curve control, bond traders are poised to keep putting pressure on the maturities that are relatively free of the central bank’s grip, according to Goldman Sachs Group Inc.
That pressure was evident Thursday when a sale of 20-year Japanese government bonds got a tepid reception, indicating that the dislocation in the cash and futures market continues to curtail investors’ appetite for debt. The bid-to-cover ratio tumbled, while the gap between 20-year bonds over 10-year equivalents is near the widest level since February 2016, according to data compiled by Bloomberg.
Last week, the Bank of Japan held firm with rock-bottom interest rates and a pledge to continue with its fixed-rate bond purchase plan. That’s despite mounting bets that the monetary authority would have to change its yield curve-control policy, which keeps 10-year yields capped in a bid to boost a stuttering economy. Instead, the bank loosened restrictions on institutions borrowing the so-called cheapest-to-deliver securities the same day.
Yet Japan’s longer-dated yields, which aren’t capped, have climbed amid a global bond selloff, steepening the curve to levels which may prod the BOJ to change its course. Australia’s central bank recently abandoned its yield curve-control, or YCC, policy amid intensifying inflation pressures.
“The markets/BOJ stalemate will for now mean continued pressure on portions of the yield curve that are less directly affected by central bank intervention, either in swaps or maturities beyond the 10-year point,” strategists Praveen Korapaty and Avisha Thakkar wrote in a note to clients Thursday.
Global funds sold the biggest amount of Japan’s government bond futures in five months last week, according to the latest exchange data. That suggests foreigners had established short bets before the BOJ decision on expectations that the central bank would have to tweak its policy. The basis trade, an arbitrage strategy popular with overseas investors, exacerbated a supply shortage of government bonds that had ramped up pressure on domestic financial institutions and forced them to turn to the bank for relief.
While the BOJ’s measures to address liquidity concerns could alleviate some dislocations, the Goldman strategists said other market dislocations could persist as long as upward pressure on global bond yields remains. They noted the continued wideness of the gap between 10-year JGBs and matched overnight index swaps.
“The potential ineffectiveness of futures as a hedging venue for JPY rates risk could not only mean reduced liquidity in these futures, but also more market fragmentation,” they wrote. “If the BoJ wants to address this broader dislocation and further potential weakening of the yen, it may ultimately have to revisit its YCC framework.”
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