Japan rates review: Barclays

Barclays notes:

We would not expect much rise in JGB yields even if the global economic cycle were to bottom out and risk-on sentiment take hold in financial markets. 

We recommend maintaining a neutral delta and waiting for the next big development, and suggest a barbell over a 10y bullet. Information has begun to emerge on the government's fiscal restructuring plan through FY20, scheduled for release in June. 

We believe investors will focus over the next month on fiscal and regulatory issues while keeping a close eye on news related to the possible start of Fed rate hikes.

We continue to recommend a 5s10s20s butterfly (sell the body), 20y ASW long, 30y JGB buy/UST sell, and 10y BEI long, positions we consider market neutral based on valuations and supply/demand conditions. 

We believe these positions could generate even greater profits if global markets switched to risk-on sentiment.Direction-wise, we believe that while yield levels will likely remain flat as a general trend, they are likely to continue fluctuating over a fairly wide range. 

We feel the best strategy would be a tactical repeated shift between long and short positions. 5y JGB auction on 19 May saw a low bid-cover of 2.80, but the market was firm in the afternoon. 

Our JGB auction bid-cover index (weighted average of bid-cover ratio in 2-40y auctions) fell to 2.64 yesterday, its lowest level for comparable data since 2007. 

Starting in April, the MoF lowered the maximum per-company bid to 50% of issuance from 100%, while raising the minimum bid to 4% from 3%. This was MoF's response to evidence, mainly in the T-Bill market, of so-called BoJ trades whereby certain participants buy up virtually an entire issue, further bid up prices in the thin secondary market, then sell to the BoJ when closing levels are high. 

One side effect is that bid-cover ratios have fallen. Given that our JGB auction bid-cover index has fallen even further in May than in April, it appears that the current system tends to exacerbate this effect when volatility is high.