"Widowmaker trade" makes a comeback: shorting Japanese government bonds becomes one of the most profitable trades this year!

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The so-called “widowmaker trade” that has wiped out countless short sellers is now transforming into one of the most profitable bets in this year’s global bond market. As the Japanese bond market undergoes its worst selloff in decades, shorting Japanese government bonds is finally generating generous returns for investors.

According to media calculations on Tuesday, Japanese government bonds have lost over 4% in total returns this year excluding currency fluctuations, making it the worst-performing sovereign bond market globally. The Japanese bond market has been under constant pressure from repeated rate hike expectations, as well as concerns that the new Prime Minister might launch large-scale fiscal stimulus.

Mark Nash, fund manager at Jupiter Asset Management, said:

Forget US Treasuries or UK Gilts—the clearest strategy now is to sell Japanese government bonds. Compared to other markets, the widowmaker trade has become one of the most profitable.

This shift is significant. The yield on Japan’s 30-year bond hit a record high this month. Goldman Sachs has marked Japan as a “net exporter of bearish shocks” in the global bond market. Political turmoil has further heightened market volatility—the new Prime Minister Sanae Takaichi has pledged cash handouts and tax cuts, sparking concerns that fiscal expansion will push up long-term yields, and the subsequent collapse of the ruling coalition has thrown Japan into its worst political crisis in decades.

The “Widowmaker Trade” Makes a Comeback

“Widowmaker trade” is a strategy that has existed in the Japanese bond market for decades—investors borrow and short Japanese government bonds hoping to buy back at a lower price. The trade earned its name because bond investors routinely lost money during Japan’s long period of ultra-loose monetary policy.

Now, the situation has completely reversed. The S&P-related Japanese bond futures index has fallen about 2% this year. Hiroyuki Kimura, portfolio manager at Western Asset Management, which manages over $230 billion in assets, said his fund has long maintained a short duration strategy in the Japanese bond market and plans to stick with this position. The trade is mainly executed by heavily shorting five-year government bonds.

Mark Dowding, Chief Investment Officer of RBC BlueBay Asset Management, revealed in an October 10th report that his firm has recently taken positions on falling prices for Japan’s 10-year government bonds, and is currently shorting duration in Japan. The firm had previously clashed with bond bulls on the “widowmaker trade.”

Multiple Factors Support the Short

The reasoning behind this trade is clear. Japan’s core inflation rate has stayed above the BOJ’s 2% target for nearly three years. While a series of rate hikes has begun since last year, Japanese rates remain extremely low by global standards.

Concerns over fiscal policy also broadly support shorts. Japan has the highest government debt-to-GDP ratio among developed countries, with a wide lead. Although recent bond auctions show some easing pressure, yields hovering near multi-year highs remain under tight scrutiny. The yen has also been the worst-performing G10 currency against the dollar over the past six months, despite the outlook for further BOJ rate hikes.

Lauren van Biljon, Senior Portfolio Manager at Allspring Global Investments UK Ltd., said:

We expect an agreement on fiscal stimulus, though the scale of spending is still unclear. This means one needs to remain cautious about duration in Japan. The yield curve is already very steep, but that doesn’t mean it can’t get steeper.

Political Turmoil Increases Uncertainty

The impact of Japan’s next Prime Minister on its $7.7 trillion bond market has become a key issue for traders.

Sanae Takaichi, who won Tuesday’s parliamentary vote to become Japan’s Prime Minister, has pledged cash handouts and tax cuts. However, traders also believe her rise will delay rate hikes. This has raised concerns that long-term bonds will ultimately bear the brunt of selling pressure, as investors fear future generations will pay for today's fiscal largesse.

Just days after Takaichi won the LDP leadership election, the ruling coalition collapsed—plunging Japan into its worst political crisis in decades. She has formed a new alliance with partners, but the risk that politics could weigh on bonds is far from over.

Market analysis suggests BOJ officials do not view a rate hike next week as urgent. On Tuesday, Japan’s five-year government bond yield fell two basis points to 1.22%.

However, this trade is not without risk. Domestic life insurers might return at year-end, boosting demand, and fiscal improvements offer the government some room to cut issuance in the next fiscal year. US rate cuts could also provide further support, as historically Japanese government bonds have correlated with US Treasuries.

Risk Warning & DisclaimerThe market involves risk, and investment requires caution. This article does not constitute personal investment advice, nor does it take into account the individual investment objectives, financial situation, or needs of any user. Users must consider whether any opinions, views, or conclusions in this article fit their particular circumstances. Investing accordingly is at your own risk. ```