Global bond investors are increasingly concerned that betting against Japanese government bonds (JGBs), a strategy historically dubbed the 'widow-maker trade,' could lead to substantial losses once again. This trade, which involves borrowing and selling Japanese government bonds with the expectation of their prices falling, gained its moniker due to repeatedly burning investors during Japan's prolonged era of ultra-loose monetary policy. For decades, global bond funds were drawn to this strategy only to be burned by it.
However, this perennial losing bet has recently transformed into one of the most lucrative plays in the global bond market. Japanese bonds have experienced significant declines this year, making them the worst performers among government bonds globally with over 4% in total return loss, excluding currency fluctuations. This downturn is attributed to on-again, off-again bets on interest rate hikes and fears that a new prime minister might initiate a spending spree, pushing up long-term yields. Goldman Sachs Group Inc. has even labeled Japan a "net exporter of bearish shocks" in the global debt market due to this sell-off.
Despite the recent profitability, the term "widow-maker trade" implies a high-risk scenario where investors could be severely impacted if the market reverses. Mark Nash, money manager at Jupiter Asset Management, noted that shorting JGBs has been "one of the most profitable relative to other markets." Hiroyuki Kimura of Western Asset Management also indicated his fund's continued short duration in Japan's bond market, primarily through a large short position in five-year bonds. The rationale behind this current profitability includes Japan's core inflation consistently above the central bank's 2% target, exceptionally low interest rates globally, and worries about fiscal policy.
There are inherent risks to this trade. Potential factors that could reverse the trend include local life insurers increasing demand towards year-end, the government reducing issuance in the next fiscal year due to improving finances, and potential US interest rate cuts, as Japanese bonds are historically correlated with Treasuries. Some investors, like Kathy Jones of Charles Schwab & Co., find Japanese bond yields attractive on a hedged basis, while Allspring Global Investments UK Ltd. advises caution regarding duration in Japan due to potential fiscal stimulus. The specter of past losses keeps investors wary, even as the trade enjoys current success.
