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Japanese Bonds Rally Again, But This Time It's a Bit Different

Japanese Bonds Rally Again, But This Time It's a Bit Different

(Bloomberg) -- It’s Japanese government bonds’ turn to take the lead in the global fixed-income melt-up as bets climb for the Bank of Japan to add to its stimulus.

Japan’s two-year yield is on course for its biggest daily drop since January and swaps indicate that traders have priced in a full 10-basis point reduction in rates by April next year. The strength of the move prompted renewed gains in U.S. Treasuries and helped push Germany’s 10-year yield to a record low.

The increased speculation around further monetary easing by Japan’s central bank comes as the yen strengthened past 108 against the dollar this week to its highest level since January.

Japanese Bonds Rally Again, But This Time It's a Bit Different

“The rally in JGBs has been led by bets the central bank will unveil more stimulus to curb the yen’s strength as the Federal Reserve appears increasingly likely to ease policy,” said Makoto Suzuki, a senior bond strategist at Okasan Securities Group Inc. Gains are being led by the medium-term sector as expectations for a rate cut by the BOJ rise, he said.

Since both the two- and five-year tenors offer negative yields that are below the central bank’s rate, some market players said that foreign buyers -- who use cross-currency basis swaps to help turn negative yields into profitable trades -- were leading the demand. The instruments allow a U.S. dollar-funded investor to pick up almost 40 basis points of additional yield from five-year JGBs above nominal similar-maturity U.S. Treasuries.

Japanese Bonds Rally Again, But This Time It's a Bit Different

Demand for long-end bonds, which had previously been leading the JGB rally, has been impacted by investor caution ahead of an enhanced liquidity bond auction on Thursday and the BOJ’s debt-buying operation on Friday, Suzuki said.

On top of the above two factors supporting flows into short-end notes, strong interest in Japanese bond futures from trend-following accounts is also adding to the demand, according to rates traders familiar with transactions, who asked not to be identified because they aren’t authorized to speak publicly.

Japan’s benchmark 10-year yield slipped 2.5 basis points to minus 0.13%, its lowest level since August 2016, while JGB futures also hit the highest levels in three years.

The 10-year U.S. Treasury yield fell 2 basis points to 2.11%, giving back some of their advance from Tuesday, when Federal Reserve Chairman Jerome Powell opened the door to possible interest-rate cuts, but stopped short of signaling any kind of imminent move. Yield on 10-year bunds dropped as much as 2 basis points to minus 0.228%.

--With assistance from Saburo Funabiki and Chikafumi Hodo.

To contact the reporter on this story: Stephen Spratt in Hong Kong at sspratt3@bloomberg.net

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Shikhar Balwani, Paul Dobson

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