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Japan’s government and central bank face important decisions in the coming weeks as they decide how best to deal with a surge to record highs in long-term borrowing costs and the prospect of a shrinking investor base for the country’s debt.
Yields on 30-year bonds, which were below 2.3 per cent at the start of the year, hit 3.2 per cent last week, while those on 40-year bonds reached 3.7 per cent, in back-to-back weeks of anaemic auctions amid renewed concerns over Japan’s debt pile. Yields move inversely to prices.
The turmoil, which has subsided slightly in recent days, has served to expose what analysts say is a structural imbalance between supply and demand for Japan’s debt, which many investors believe will weigh heavily on prices.
A significant driver has been demographics. The remaining life expectancy of the large and wealthy generation of postwar baby boomers is less than 20 years, compared with around 40 in 2000. This, according to Kevin Zhao, head of global sovereign and currency at UBS Asset Management, is leading to a big structural change in demand for long-dated government bonds.
“This group [no longer] needs to invest for the very long term. But most government officials have not realised this structural change [is happening],” said Zhao, noting that Japan keeps issuing very long-dated bonds.
In addition, life insurance companies are no longer the dependable source of demand they have been. Under regulatory pressure, they raised their allocations to very long-dated bonds last year. However, traders say that process has run its course.
Last week’s rise in 20-year yields to 2.61 per cent followed an auction of 20-year government debt that drew the weakest demand since 2012. This week, a closely watched auction of 40-year debt was also poorly received, attracting the lowest bid-to-cover ratio since last July. This, said traders in Tokyo, confirmed the ongoing “buyers’ strike”.
These issues have come to the fore as the Bank of Japan has pushed ahead with efforts to “normalise” monetary policy and restore positive interest rates.
As well as raising rates to 0.5 per cent, since last year the BoJ has been reducing its total bond purchases by Y400bn ($2.8bn) per quarter, and plans to continue that pace until March 2026.
For many years, investors have questioned how the authorities plan to juggle the political and financial realities of a gross debt-to-GDP ratio that has risen to almost 250 per cent, and a central bank that has built an unorthodox, market-distorting position where it holds roughly 52 per cent of the debt market.
Analysts point to the week of June 16 as crucial in determining where borrowing costs go from here.
That week includes a two-day meeting of the BoJ’s Monetary Policy Committee, at which it will review the past year of reduced bond buying. Some in the market believe that, given the turmoil, the committee may decide to slow the pace at which it tapers its purchases, in an effort to keep a lid on yields.
Later that week, the Ministry of Finance is scheduled to discuss debt issuance plans with market participants and could decide to scale back sales at the super-long end. Yields fell on Tuesday after it emerged that it had begun canvassing prime brokers and other market participants on their perception of the bond market.
In a note to clients, economists at JPMorgan said the speed of the rise in super-long end yields meant the BoJ’s upcoming review of quantitative tightening would assume greater importance for markets.
However, Benjamin Shatil, senior economist at JPMorgan, said the BoJ appears to be behind the curve as Japan enters its fourth year with headline inflation above target.
In addition, he pointed to the massive Government Pension Investment Fund not raising its allocation to domestic assets over foreign assets, and rapidly tightening liquidity in the commercial banking sector.
“It all begs the question — why buy?” he said.
Shinichiro Kadota, a rates and FX strategist at Barclays in Tokyo, said that following Wednesday’s weak auction of 40-year debt, the key would be the finance ministry’s communications on its plans for future issuance.
The super-long end of the JGB market, he said, was expressing issues that had been brewing for some time, but, like BoJ normalisation and the potential need for Japan to raise defence spending, had become more material.
He added that, apart from regulatory changes, income for Japanese life insurers was on the decline as their products faced increased competition from other investment vehicles and the tax-protected investment accounts — known as NISA — that have been heavily encouraged by the government.
Kadota said it was unlikely the BoJ would pull back on reducing JGB purchases. “There may be some tweaks . . . but the solution has to be the Ministry of Finance [reducing] issuance,” he said.
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