It takes a lot to rattle Japanese government bonds. But on Friday, the world’s biggest bond market went into freefall. The yield on 10-year JGBs jumped 12.5 basis points to 1.6 per cent. Futures trading screeched to a halt – the first enforced stoppage since new systems were introduced at the start of the year.
Part of the rush for the exits can be explained by global concerns about higher inflation. The $6,700bn JGB market has a habit of selling off when US interest rates bottom. Many expect a cut next week by the US Federal Reserve to be the last in this cycle. Against this backdrop, foreigners were keen to reduce their positions.
What should have been an orderly unwinding, however, turned into a rout because of technical issues. A string of national holidays, kicking off on Tuesday, means trading volumes will be feeble over the next fortnight. That period also coincides with the Fed meeting and the Bank of Japan’s economic outlook, which is expected to prune growth expectations. It would take a brave bondholder to take a contrarian stance ahead of a week like that.
In such a febrile environment, volatility is a given. Signals are changing at lightning speed. Derivative markets are now factoring in a 100 per cent probability that the Bank of Japan will raise interest rates by early next year, according to JPMorgan, reversing the massive odds of a cut barely a month ago. The spread between inflation-linked and conventional bonds ballooned to 25 basis points – quite a reaction to Friday’s inflation numbers. That data reinforce the view that Japan is near the end of deflation but, at 0.1 per cent year on year ex food and energy, such a rise is a rounding error. It is seldom said but the JGB market will be no place for the fainthearted in coming weeks.