If Friday's session is any indication of what to expect in a few minutes when JGB trading resumes, we are about to have a doozy of a session on our hands (especially with Interactive Brokers already announcing all intraday margins [9]on all Japanese products for Monday trading have been lifted). As a reminder, the 10Y JGB suffered only its second most volatile trading day ever this past Friday [10]when the yield plunged by half (!) to 0.30%, then doubled in a matter of minutes to 0.60% - a 13 sigma move [11]- and the bond trading session was interrupted by two trading halts when it seemed for a minute that the BOJ may lose all control of the bond market. Well, judging by the absolutely ridiculous moves in the USDJPY as of this moment, with the pair soaring 70 pips in a matter of seconds, we are about to have precisely the kind of insanely volatile session that the Japanese Finance Ministry itself warned may lead to a wholesale selloff in JGBs, offsetting even the New Normal Mrs Watanabe kneejerk which is to merely frontrun the BOJ in buying JGBs. Why? Because with implied vol exploding, VaR-driven models will tell banks to just dump bonds as they have become too volatile to hold on their books. The problem is that with trillions and trillions of JGBs held by banks, insurance companies and pension firms, there just not may be anyone out there to buy them.
This is from the October 26, 2012 minutes of the Meeting of JGB market special participants [12], just as the insanity known as Abenomics was being first revealed to the world.
Another thing to be noted here is the fact that as a risk management method, many domestic financial institutions adopt the VaR approach, which is designed to calculate the amount at risk on the basis of volatility. Under the present circumstances, we can determine the amount at risk to be small because of not great volatility. But if the volatility moves up or down in the order of 0.5% to 1.5%, it will increase the amount at risk, forcing domestic financial institutions to reduce their JGB holdings.
0.5% or 1.5%? Try ten times that. The chart below shows the implied vol of the 10Y JGB in recent days. If any financial institution still adhering to a VaR approach hasn't puked its bond holdings, it will shortly.
[13]
Perhaps it is not, then surprising, that the one rhetorical question the MOF had was the following:
Here, we have one question. What will happen to interest rates payable on 15-Year Floating-Rate Bonds or Nonmarketable JGBs for Retail Investors in case the 10-Year Bond auctions are suspended?
Yes, what will happen if the BOJ has managed to literally break the bond market?
Away from the dramtic shifts in JGBs, the last 3 days have seen the 2nd largest weakening in JPY in 25 years...
[14]
...and most notably the relationship between JPY (as a funding currency for every and any risk trade around the world) has experienced a rather interesting transition change in the last month...
Green Oval = Normal: JPY weakness funds FX carry to buy stocks and thus bond yields rise.
Orange Oval = Transition: unwinding of those trades led to JPY strength...
Red = New correlation: the BoJ drops the shock-and-awe hand grenade and confirms JPY investors' concerns that their wealth is being destroyed - the Treasury buying begins and stocks get sold.
[15]
...or perhaps the 'strength' in JPY relative to EUR in recent weeks (the ultimate JPY carry trade) is now being squeezed back to reconnect with the US equity market
[16]
Perhaps the post-Lehman decoupling between USDJPY and the long-end of the JGB curve is back... which means JGBs imply 110 USDJPY is coming. Interestingly the collapse in the JGB curve took it back to the same time when USDJPY was here last - mid 2009...
[17]
Charts: Bloomberg