Investors around the world are unnerved by a new wave of volatility on Japan’s government bonds market. This is due to signs of a weakening demand for debt with long maturities and growing concerns about the implications for global financial markets.
For decades, Japan’s $7.8 trillion debt market was considered one of the world’s most stable.
This status is now being questioned. In recent weeks, the auctions of 20- and forty-year Japanese government bond have recorded some their lowest demand in years.
The global bond market has been under pressure since US President Donald Trump introduced tariffs in his “Liberation Day Plan” in April.
The yields on government bonds with a maturity of 40 years hit a record high of 3.689% in the past week. They were last seen at 3.318, which is nearly 70 basis points more than the start of this year.
The 30-year yield has risen by more than 60 basis point to 2.914%. Meanwhile, 20-year notes have increased by over 50 basis points.
Why is the demand for Japanese government securities falling?
The Bank of Japan’s efforts to reduce the size of its domestic bond market are a major source of anxiety.
The central bank of Japan has played a dominant position in the domestic bond markets for many years. It has amassed vast holdings of government bonds as part of its battle against persistent deflation, a fight that began in 1990s during the “Lost Decades.”
The BOJ has changed its course as Japan slowly emerges from deflation.
The central bank is no longer focusing solely on economic stimuli, but is now reducing its massive balance sheet.
After its holdings in government debt reached a record high of Y=21 trillion (146 billion dollars) in November 2023 the BOJ has since reduced its quarterly bond purchases to Y=400billion.
Source : Bloomberg
The central bank’s decision to reduce its bond purchases has raised a question: Who will buy the bonds if not BOJ?
The risks have been highlighted by a disappointing 20-year bond sale on May 20, followed on May 28 by a weak demand for bonds with a 40-year maturity.
The Japanese Finance Ministry has reportedly asked market participants for feedback on whether or not to adjust the issuance and maturity of longer-term debt. This highlights growing concerns within government circles.
Investors are becoming increasingly concerned that Japan’s bond-market woes may have a global ripple impact, especially through the channel of capital flow.
Fears of Japan selling US bonds due to rising yields
The sharp rise in Japanese yields threatens the popular carry trade, where investors borrow low-yielding Japanese yen and invest in higher-returning assets abroad, often in the US.
Deutsche Bank AG warned that rising Japanese rates would make bonds more appealing to local buyers, and as a result could cause investors pull money out of US debt.
Macquarie analysts believe that a “trigger” point may be reached when the yield gap narrows to a point where domestic bonds are more attractive than US assets.
Albert Edwards, a Societe Generale analyst, warned in a CNBC article that such a move could trigger a “global market Armageddon,” especially if it affects US technology stocks which have benefited from strong Japanese inflows.
The strengthening of the yen — which is up more than 8 percent this year — will only accelerate that shift.
He said that tightening global liquidity would reduce world growth to just 1%. By raising long-term rates, he would tighten financial conditions as well as extend the bear market for most assets.
This repatriation is synonymous with “the end of US exceptionalism”, and is mirrored in Europe & China,” Roche said.
Source: Bloomberg
Strategists are worried about a repeat of August’s carry-trade unwind
The last major unwinding of yen carry-trades occurred in August 20, 2024 when the BOJ surprised the markets by raising interest rate.
Investors rushed to close positions as the yen surged and global markets fell.
Some strategists are now concerned about a repeat.
Alicia Garcia-Herrero, economist at Natixis, said that the unwinding could be even worse.
Others, however, suggest that this time the carry trade is on more shaky ground.
Guy Stear, Amundi, points out that the yield difference between Japanese and US 2-year bond has narrowed since last year. It is now around 320 basis point. This makes the incentive to short the yen less compelling.
Guy Stear, Amundi’s head of developed market research, said that “big carry positions” are typically created when there is either a strong FX tendency or low FX volatility and [when] a large short-term interest rate differential.
Riccardo rebonato, professor at EDHEC Business school, told CNBC that he saw “progressive erosion” rather than an explosion over a period of time.
US asset exposure still favours equities
Despite growing fears of a capital withdrawal, some analysts believe that Japan’s large holdings in US Treasuries – long seen as stabilizing forces – are unlikely to be sold en masse.
Masahiko loo of State Street Global Advisors stated that these holdings were “structural” as part of the US-Japan Alliance.
State Street data also shows that Japan’s exposure is heavily skewed towards equities with nearly $18.5 trillion of stocks compared to $7.4 trillion in Treasuries.
According to Apollo’s Chief Economist Torsten Slok any capital flight will likely start with equities and then move on to corporate bonds – not Treasury bonds.
Concerns about Japan’s exploding debt persist.
Shigeru Ishiba, Prime Minister of Japan, recently compared the country’s fiscal situation to that in Greece. This sparked renewed scrutiny about whether the government could sustain rising borrowing costs.
All eyes on BoJ to turn the tide
As a sign of increasing pressure, major life insurance companies and pension funds have asked Bank of Japan to take more aggressive action to stabilize the bonds market.
The BOJ will review its bond-purchase plans in June. Governor Kazuo ueda has promised to closely monitor market developments.
The Finance Ministry’s decision to consult with market participants about super-long bonds issuance indicates that authorities are struggling to restore balance to an market once defined as stable.
Japan’s bond markets have changed from a place of calm to a source of global disruption.
Investors will be watching to see if the world’s largest and most indebted economy can weather the storm – or if the fuse has already lit.
This post Rising Japanese Bond Yields Stoke Global Market Fears: Can BoJ Calm Investors? This post may be updated as new information becomes available
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