JGBs dip as risk aversion eases

Japanese government bond prices dipped on Friday, pushing the 10-year yield off a one-year low hit the previous day, as worries about Italy eased somewhat after an Italian debt auction went better than feared and the country moved closer to a unity government. The yield curve flattened on short-covering in the longest maturities, such as 30- and 40-year bonds, while implied volatilities on options for JGB futures fell to the lowest levels since 2003 after many months of rangebound trade.
"Some market players are still selling options because the market is hardly moving these days," said a fund manager at a Japanese asset management firm. "When volatilities are so low and options are sold so much, the risk that the market will eventually get out of range grows," he added.
Ten-year JGB futures dipped 0.05 point to 142.87 while the 10-year bond yield rose 0.5 basis point to 0.965 percent, off a one-year low of 0.9660 percent struck on Thursday JGBs have been stable in the past three months, with the average daily move in the 10-year yield at just 1.2 basis points, compared with 6.9 points in the US Treasuries.
While worries about the debt crisis in Europe have supported the market as investors sought shelter in JGBs, which are mostly financed by domestic investors and seen not in danger of the capital flight seen in some eurozone countries, buyers have been cautious about chasing JGBs higher.
Many investors do not want to repeat their experience last year when the fall in the 10-year yield to a seven-year low of 0.82 percent last November was followed by four months of a painful bear market. "No one has been excited about the market. Investors have been buying cautiously, not wanting to take huge risk," said Koji Ochiai, senior market economist at Mizuho Investors Securities.
Many market players expect investors' cautiously bullish stance to stay and any further rally to come at snail's pace. The market's narrow trading band has sparked option selling, helping to bring down implied volatilities on the 10-year JGBs to the lowest level since 2003. Although some say the fall in implied volatilities - which means many players are ill-prepared for sudden swings in the market - may be leading to the risk of unexpectedly sharp moves, not many market players see that happening in the near future.
The longer end of the market continued to benefit from relief after Thursday's 40-year JGB auction drew strong demand. "The 40-year auction yesterday was surprisingly strong. The bonds looked very cheap on the curve so that's why there was strong demand," said Satoshi Yamada, chief quantitative analyst at SMBC Nikko Securities.
The 30-year bond yield fell 2.0 basis points to 1.905 percent, while the 20-year bond yield fell 0.5 basis point to 1.710 percent. The spread between 10- and 30-year yields tightened to 94 basis points from an eight-month high of 99 basis points, hit before the auction. Yamada said the superlong sector no longer looks cheap and that further flattening in the yield curve may be limited.
"This is just a reversal after the auction. We have a 20-year bond offering later this month and I don't see the curve continuing to flatten," he said. In late trading, trading of cash bonds at the main interbroker trader Japan Bond Trading Co was briefly halted due to technical glitches, the second time in less than a month, but it had little impact on price action.