The process of shorting bonds is simple. The key ingredient is not owning the securities you sell. You borrow bonds from a broker. If you think rates will soon rise, which will lower the bonds' value, you sell. You buy them back at a later date for less than you paid. You give the bonds back to the owner and pocket the difference. Shorting is a way to make money from a declining market. Since Japan has a history of keeping rates very low, shorting in Japan might be a smart move in the near future.
1. Borrow your bonds when rates are low. As of September 2011, Japanese interest rates are very low, and have been such for some time. According to the Bank of Japan's website, their policy is to keep rates very low, as close to zero as possible, even as they need to spend more money on infrastructural projects after the 2011 earthquake.
2. Watch Japanese financial statistics closely. What you are really betting on is whether or not the long-term reconstruction costs of post-earthquake Japan will force the central bank to raise rates as more Yen are pumped into the domestic economy. The theory is that the more the Japanese must spend on these and related projects, the more the Bank of Japan must keep inflation in check.
3. Connect the relationship between the American and Japanese economies in your mind at all times. If the earthquake reconstruction costs do not force the Yen up, then the continued American economic problems might. If the Japanese equity markets continue to take hits because of their investments in American dollars, firms and market in general, this may force a compensatory rise in rates.
4. Watch China. The Chinese economic and military surge has Japan extremely worried about their place in the Pacific economy. Several things can occur that might force rates up. First, a military threat from China might force higher military spending. Second, a depressed American market will increase Japanese debt, which is already a severe problem. Financing bad investments might cause more money to flow from the country, leading to a necessary increase in rates. Finally, if the American dollar continues to fall, then Japan might have to constantly back it so as to keep Japanese exports competitive. In short, whatever forces the Japanese government or economy to spend more Yen quickly might force rates upward, something that has not happened in Japan for 15 years. Japan has never been considered a good bet for shorting bonds, but recent events might change that, at least for the short term.
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