By: Editorial Team, StoneX Media
Japan's 30-year government bond yield has climbed from effectively zero during the deflation era to record highs, and the mechanism behind that move is a change in who owns the debt. Balance sheet runoff removes the one buyer that never assessed whether a yield represented an attractive return, and hands pricing power to investors who do. The Bank of Japan bought Japanese government bonds for monetary policy transmission reasons, which made it relatively insensitive to price, and that process is now reversing. As its holdings shrink, banks, insurers, pension funds, foreign investors and households absorb the supply instead, and each of them requires compensation for the risk. The result is a long end that has backed up far more aggressively than the front, where rate expectations dominate.
David Scutt is a Senior Market Analyst for Global Macro at StoneX Media, with more than a decade spent as a foreign exchange spot, forwards and money markets dealer inside bank treasury, where he managed interest rate and liquidity risk. He produces technical and fundamental analysis across foreign exchange, commodities and equity indices, and he tracks the funding and duration dynamics that determine who is willing to hold long dated government debt and at what price.
Quantitative easing created a buyer whose purchase decision had nothing to do with return, and the Bank of Japan is the clearest example of it. Its holdings of Japanese government bonds peaked before beginning a steady decline as the bank allows the balance sheet to run down, and its share of the market has fallen materially from that peak. "Central banks were enormous buyers of government debt. They bought for monetary policy transmission reasons, not because the yield represented an attractive return that made it relatively insensitive to price. But now that process is reversing", Scutt says. Consequently, the volume of paper that has to find a genuine home is rising at exactly the moment governments are running large fiscal deficits on top of already heavy debt burdens. Specifically, this is not a Japanese peculiarity, since other central banks have been letting bonds bought during quantitative easing mature and roll off their own balance sheets.
According to Scutt, "more bonds have to be absorbed by investors who actually care about the price, their pain and the risks that they're taking", which is the practical definition of the handover now underway. Banks, insurers, pension funds, foreign investors and households each require payment for inflation risk, fiscal risk, supply risk and the outlook for rates over a 30 year horizon, and that payment is term premium. The gap between short dated and long dated Japanese government bond yields has widened well beyond what rate expectations alone would justify, evidenced by a long end that has moved far more than the front. Notably, record long term yields are being reached while the Bank of Japan still owns close to half the market and investors remain aware it retains the ability to step back in, so the true clearing level is arguably higher than the one on screen. As Scutt puts it, "Japan faces an uncomfortable trade off. Allow bond yields to rise, or risk more of the adjustment showing up through a weaker yen".
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--- Written by Frédéric Guétin, StoneX Media Producer
--- Expert: David Scutt, StoneX Media Senior Market Analyst
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