Japan’s stock market has risen more than 55% (despite recent correction) since the announcement of new aggressive stimulation package to pull the Japanese economy out of its deflationary spiral and stoke inflation.
But while the real economy seems to be on the growth path now, businesses still seem reluctant to spend and consumer spending also cooled off after a nice rise in the first quarter.
Some of the unintended consequences of ‘Abenomics’ are evident in the Japanese government bond (:JGB) market, which has seen increasing yields and a spike in volatility, of late. (Read: Buy these ETFs to profit from sector rotation)
JGBs yields have been rising since April and contradict the central bank’s easing objective. At the beginning of April, when BOJ announced a plan to purchase more than ¥7 trillion ($68 billion) of bonds every month, the 10 year yields were hovering around 35 basis points. A few weeks later they touched 1%--a level not seen in more than one year.
Market sentiment towards bonds has also been hurt by reports that Japan’s public pension fund, with over $1 trillion in AUM, is planning to increase its allocation to Japanese stocks. Many other Japanese institutions also have been decreasing their exposure to bonds and increasing their exposure to equities. Recent data released by BOJ showed that major banks in Japan have been offloading their JGB holdings.
Further, the government’s inflation and interest rate objectives seem to be contradictory. If investors expect inflation to go up then they will not hold long-term bonds. The volatility in the bond market has also gone up due to a sharp decrease in liquidity caused by massive bond purchases by the BOJ. (Read: Inside the crash in Japan ETFs)
Minutes of the recent BOJ meeting revealed that one member of the board noted that “rise in interest rates "could indicate a pick-up in expected inflation rates and an underlying upturn in economic activity” while some other members thought that BOJ's planned bond buying and its price target might have been perceived as "contradictory", resulting in increased bond market volatility.
Increased market volatility could result in a VAR related sell-off, similar to the one in 2003 when Japanese banks and foreign investors were forced to sell their JGB holdings as a spike in volatility caused their holdings to exceed internal value-at-risk (VaR) limits. Some Japanese banks having large holdings of JGBs are extremely sensitive to interest rate volatility shock.
The market focus has now shifted to BOJ’s meeting with market participants on Wednesday. However, the long-term direction of the Japanese stock and bond markets will now be determined by Mr. Abe's package of structural reforms, expected to be unveiled sometime this month. The package will contain reforms in the areas of immigration policies, labor market, health-care sector and farm sector. (Read: REIT ETFs crushed, time to panic?)
Investors looking to profit from a potential sell-off in JGBs can consider the following two inverse JGB ETNs.
PowerShares DB Inverse Japanese Government Bond Futures ETN (JGBS)
Investors seeking exposure to a short position in 10-year JGB futures might target JGBS which looks to track the DB USD Inverse JGB Futures index. Launched in November 2011, the note provides unleveraged exposure to the U.S. dollar value of the monthly returns on a short position in 10-year JGB futures plus the monthly T-Bill index returns.
So far, the product has attracted assets of $35 million and charges 50 bps in fees annually. The
ETN has generated returns of about 1.98% in past four weeks, while daily volume currently comes in around 60,000 shares a day.
PowerShares DB 3x Inverse Japanese Government Bond Futures ETN (JGBD)
This ETN offers investors three times inverse exposure to the monthly returns on a short position in 10-year JGB futures plus the monthly T-bill index returns in U.S. dollar terms. Similar to JGBS, the product is based on the DB USD Inverse JGB Futures Index, net of fees and expenses.
With assets of about $55 million, the note delivers three times negative return of JGBS, which comes to 5.27% in the past four weeks. Daily volume for the note is about 75,000 shares. It charges annual expenses of 95 basis points.
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