Weekly Japan rates review

It is believed that further BoJ easing this year could be triggered by a contraction in GDP in Q3 15 or appreciation of the yen to 115/USD. Such risks, unlikely as they are, will continue to weigh on markets until October. The easing scenario will not be realized and that yields will trend upward from November through year-end. Nevertheless, we cannot entirely rule out the possibility of further BoJ easing and a sudden drop in yields.

"We maintain a neutral position directionwise and slight flattener position on the curve. We recommend buying a straddle with longish expiry, such as a 1y10y. We remain cautious on the USDJPY basis market", says Barclays.

JGB yields have trended slowly but steadily downward since the start of Q3, led by the 8-10y sector. In contrast to the high volatility sustained in the year's first half, intraday movements have remained narrow. Downward pressure on yields has dominated since July on fears over the Chinese economy, the renewed downturn in oil prices and the plunge in stock markets worldwide after China's devaluation of the CNY. 

Nevertheless, yields would appear to have little room to fall (unless an unexpected development necessitates BoJ easing), and activity by market participants has subsided. It is believed that the BoJ will reach a decision on whether to pull the trigger on additional easing measures in Q4 15, which will determine whether yields return to the lows of Q1 or touch a new high for the year. 

USDJPY basis has seen wider negative margins into September. If the private sector comes to finance global imbalances, there could be a risk of xccy basis levels changing over an extremely prolonged period. There is a concern that Japanese banks will turn to the xccy basis swaps market to fund some of the USD they were unable to raise in CP. This would serve to widen negative margins for basis. It is difficult to ascertain how much the market has factored in such a development.