John Templeton hated the contrarian claim “this time it’s different”. The US investor would have disapproved of fund manager BlueBay betting that Japanese government bond yields will jump.
This dangerous vote of no confidence in the policies of the Bank of Japan is known as “the widow maker trade”. But the sharpest surge in inflation in four decades puts bond vigilantes on a stronger footing.
Betting against central banks can work in certain situations. Some investors took positions against the dollar-based currency regime of Argentina, which collapsed in 2002. But even its Convertibility Plan lasted for over a decade, and the Bank of Japan is a more formidable opponent.
The Federal Reserve and the European Central Bank are raising interest rates to attack inflation, The US central bank is increasingly likely to increase by 0.75 per cent to 1.5-1.75 per cent. That makes the BoJ an outlier. It has continued to cap yields of longer-dated 10-year JGBs at 0.25 per cent.
A gap between JGB and US Treasury yields has therefore opened up. BlueBay, a London-based unit of RBC, believes the yield cap must rise. A 14 per cent drop in the yen this year inspires bearishness. Inflation has climbed to its highest rate since 2014.
We have been here before. Fund managers who shorted JGBs in 1993, 2003 and 2013 failed miserably. One reason was that Japan’s economic growth was stumbling, then as now. Local investors dominated the holdings of JGBs with more than 90 per cent of outstanding debt. That remains the case. Foreign holdings have grown, but only to 14 per cent by December last year.
Nervous foreigners make little difference to outcomes, agrees BlueBay’s chief investment officer Mark Dowding. Domestic holders will, however, trim JGB holdings. Japan has the highest debt-to-GDP ratio among all economies, at more than 250 per cent. The combination of a cost of living squeeze and an approaching natural limit to BoJ bond purchases should force compromise.
Global inflation shows no sign of abating. Raising the yield cap would at least allow the BoJ to declare victory against decades of deflationary pressure. Short sellers of JGBs may not rival George Soros, who drove sterling out of the European Exchange Rate Mechanism. But they could make the widow-maker trade look much less formidable.
The Lex team is interested in hearing more from readers. Please tell us in the comments section below whether you think it makes sense to short JGBs.