By Junko Fujita
TOKYO, Feb 7 (Reuters) - The Bank of Japan's aggressive
market operations to defend its policy band for yields has not
only sapped liquidity in the government bond market but also
drastically limited scope for speculation in bond futures.
Years of bond buying by the BOJ under its
yield-curve-control (YCC) policy have distorted the Japanese
government bond (JGB) market by artificially suppressing parts
of the curve and causing illiquidity as the BOJ's ownership of
benchmark bonds has ballooned.
That illiquidity has affected the futures market ,
which banks and investors use not only to speculate on bonds but
also to hedge their interest rate risks.
A surprise adjustment to BOJ policy in December was supposed
to improve the operation of the market but hardly did so. In
that move, the central bank widened the band in which 10-year
yields could move a 50 basis points either side of zero from 25
basis points.
"The BOJ said it widened the upper end of the 10-year bond
yield to correct the market function," said Kentaro Hatono, fund
manager at Asset Management One. "But instead, to defend its
0.5% cap it destroyed the market function."
The move only heightened market speculation that the BOJ
would further loosen or abandon its yield-control policy,
forcing it to buy even more bonds to defend its new upper limit.
(For more on how YCC works, see )
Traders say betting on such policy change through futures
has now become prohibitively expensive.
They cannot profitably short-sell the nearest three-month
futures contract , maturing in March, because the BOJ
owns most of so-called cheapest-to-deliver bonds that the
futures contract is pegged to. In April, the BOJ began buying
unlimited amounts of 10-year bonds daily and then in June
widened that policy to the cheapest-to-deliver bond, of seven
years' duration.
By Jan. 31, the BOJ owned 103.1% of the 358th series of
10-year bonds that the March futures contract is tied to,
Keisuke Tsuruta, a strategist at Mitsubishi UFJ Morgan Stanley
Securities wrote in a note to clients.
In a typical transaction to bet on higher yields, traders
would sell futures, wait for a fall in the futures price - which
moves inversely to yields - then settle the contract at maturity
by delivering physical bonds or futures.
As investors rushed to buy back the March futures, the price
of that contract has risen sharply.
That has meant that speculators cannot even roll over their
March short positions to June without paying heavily.
"We have to buy back March futures at an unreasonably high
price, and sell June futures at an unreasonably low one," said
Hatono. "With the spread this wide just for three months,
returns from hedging are wiped out."
The spread between futures maturing in March and June stood
at 1.30 yen on Monday, after widening to much as 2.34 yen on
Jan. 23, the biggest gap since Sept. 1999. In early December it
was 0.6 yen.
The central bank bought a record 23.69 trillion yen ($182
billion) of bonds in January through its outright purchase
operations, the latest BOJ data shows. Because it also lends
those JGBs to banks, and they sell bonds to other investors who
then sell some back to the BOJ for cash, it ends up owning more
than 100% of some bond issues.
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(Reporting by Junko Fujita; Editing by Vidya Ranganathan and
Bradley Perrett)
