A sharp flattening of the Japanese government bond yield curve following Takachiho's election victory has prompted a reassessment of previously popular Wall Street trading strategies. Analysts now argue that the market's interpretation of Takachiho's win has been overextended, with risk dynamics shifting to favor a renewed steepening of the curve.
Financial institutions including Citigroup and Deutsche Bank have unwound trades betting that short-term Japanese bond yields would rise faster than long-term yields. This move aligns with a similar position adopted earlier by Société Générale, signaling a collective view that current risk conditions now support a curve steepening trade.
This shift in outlook comes as Takachiho nominated two new Bank of Japan board members perceived as monetary policy doves, alongside reports expressing her concerns about additional interest rate hikes. Société Générale strategist Stephen Spratt and colleagues noted in a report, "We believe the JGB curve flattening has gone too far and now appears excessively flat relative to our model. Given fiscal policy uncertainty, upcoming long-term bond supply, 30-year yields near range lows, and BOJ policy uncertainty, we favor tactical reversal positions."
Market impact was already evident by Wednesday as short-term bonds rallied on fading rate hike expectations, while long-term yields climbed amid concerns that the central bank might fall behind the inflation curve under a more accommodative policy stance. The yield gap between 2-year and 30-year JGBs consequently widened again.
Deutsche Bank strategist Francis Yared's team recommended exiting further bets on Japanese yield curve flattening after approximately 25 basis points of flattening materialized, citing valuation concerns and the nomination of dovish board members. Similarly, Citigroup's Dirk Willer and colleagues closed positions tied to expectations of higher terminal rates and more hawkish BOJ policy—positions originally based on assumptions that policy tightening would be needed to support the yen—though they maintained long positions in Japanese equities.
Following Takachiho's election victory, Japan's yield curve experienced significant flattening as markets anticipated she would pursue a fiscal agenda balancing aggressive expansion with fiscal discipline, strengthening the case for gradual policy normalization. The spread between 2-year and 30-year JGB yields had narrowed from January's peak to around 210 basis points.
However, emerging signs suggest Takachiho's policy preferences may be more accommodative than initially assumed, potentially reigniting bond market selling pressure and volatility reminiscent of last month's sharp selloff. SMBC Nikko Securities strategist Ataru Okumura noted, "Overseas investors may have misjudged the reflationary stance of the two nominated BOJ policy board members." He added that this could lead to "additional curve steepening distortions" in bond markets, where short-term yields fall while long-term yields rise, thereby widening the spread between them.
Comments