Global funds, Japan banks have big opposing bets on JGB futures

OPEN interest in Japanese government bond (JGB) futures is hovering around the highest level in two decades as global funds and local players take opposing bets in a market that remains distorted by the central bank.

While the locals are shorting JGB futures as foreigners pile into longs, the positioning doesn’t necessarily reflect wagers on the direction of Japanese yields, which have whipsawed since a policy tweak by the Bank of Japan (BOJ) on Jul 28.

Analysis of data from Japan Exchange Group, Japan Securities Dealers Association and insights from Tokyo-based rates strategists indicate that overseas buyers have been accumulating longs in futures since last year, while shorting the underlying bonds. They appear to be chasing arbitrage profits in so-called basis trades that benefit from narrower price differences between futures and bonds.

At the same time, Japanese commercial banks – via trust banks and investment trusts – are shorting futures in a likely attempt to hedge against losses in their huge holdings of the underlying bonds as prices fall amid upward pressure on rates. The benchmark 10-year yield last week touched the highest since 2014, before slipping in recent days amid unexpectedly weak wages data.

At the centre of the picture is the BOJ, which is starting to relent in its years-long campaign to suppress yields. While wagers by global funds against the BOJ’s yield-curve control have often grabbed headlines, flows data suggests basis trades are also a big focus.

“Not all foreign investors bet on ups and downs in yields,” said Keisuke Tsuruta, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo. “They have learnt that basis trades are more lucrative than selling JGBs only to get squeezed.”

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For now, Tsuruta is watching for any sizable reduction in open interest. “If yields struggle to rise, holders of bear funds will unwind their positions to cut losses,” he said. “If yields rise, they will still sell to take profit.” BLOOMBERG