A $2tn debt deluge is set to flatten Japan yield curve
May 31 2020 11:45 PM
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Commercial and residential buildings stand as the sun sets in Tokyo. Staring at a record debt issuance this fiscal year, traders in Japan’s sovereign bond market are signalling that the $2tn deluge will flatten the nation’s yield curve.

Bloomberg/Tokyo

Staring at a record debt issuance this fiscal year, traders in Japan’s sovereign bond market are signalling that the $2tn deluge will flatten the nation’s yield curve.
That’s owing to two factors. First, the bulk of the increase in government debt sales is in shorter-maturities where waning foreign demand is already pressuring yields to rise, even after the Bank of Japan ramped up purchases. At the other end of the curve, rising investor demand for super-long bonds is seen driving yields lower in the sector.
While shaping their expectations based on Japan’s current fiscal and monetary policy mix, analysts are quick to point out that the BoJ’s bond buying remains the joker in the pack. The central bank late on Friday paved the way to boost its purchases of bonds with three-to-10 year maturities.
“Local yields are now driven by the balance between fiscal policy on the supply side and central bank buying on the demand side,” said Koichi Sugisaki, a strategist at Morgan Stanley MUFG Securities Co in Tokyo. 
“The curve is biased for flattening, given the strong demand for super-long bonds.” 
Here is a look at what’s playing on different parts of the curve:
Super-long bonds: Depressed global yields are driving Japanese investors towards these positive-yielding securities. Local insurers, among the biggest holders of fixed-income assets, snapped up 1.53tn yen ($14.3bn) of super-long JGBs over April and March, the biggest two-month take up since 2013.
That’s even as they are known to typically allocate funds abroad at the beginning of the fiscal year in April.
“It’s a surprise to see insurers adding super-long bonds from the start of a fiscal year,” said Takafumi Yamawaki, head of local rates and FX research at JPMorgan Securities Japan. “It suggests they will be more active in allocating to JGBs this year.”
The BoJ has kept its purchases of bonds maturing over 10 years largely unchanged so far in 2020. That’s a far cry from last year, when its tapered super-long purchases aggressively in a bid to steepen the yield curve.
The benchmark: Analysts see the 10-year yield sticking to a narrow range around zero per cent under the BoJ’s yield-curve control policy. That’s even as strong collateral demand amid the introduction of a new lending programme saw Japan’s biggest banks in April buy the most 10-year JGBs in about six years.
Any downward pressure on yields from collateral demand owing to the BoJ’s loan programme for small business wouldn’t be too strong, said Naomi Muguruma, senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co in Tokyo. “It’s unrealistic to expect banks to lend explosively. It’d be a slow process.”
The BoJ’s reluctance to cut its negative rates further also indicates that the benchmark yield’s “range-bound moves will continue,” she said.
The 10-year yield touched a five-month low of minus 0.2% in March, before climbing to its 2020-high of 0.095% later the same month, as the coronavirus pandemic roiled global markets. The yield has largely traded around 0% over the past two months.
Short/medium tenor bonds: With all Japanese debt due under 10 years already carrying negative yields, the surge in issuance in this sector is particularly concerning for market watchers.
Of the 59.5tn yen increase in debt sales announced by the Ministry of Finance this week, 35.6tn yen will come from six-month bills. One-year bills will contribute 9.9tn yen while a combined 9tn yen will come from two-and five-year notes. There will be no increase in 40-year bond issuance.
Yields on Japan’s 2- and 5-year bonds have risen in May even after the BoJ boosted its buying of bonds with maturities of one to 10 years to soften the impact of increased government borrowing. The central bank on Friday made some changes to its monthly bond-purchase plan, which included raising the number of days on which it will buy 3-to-5 year notes in June to six from five in May. Overall, the tweaks suggest the total amount to be spent on buying of 3-to-10 year securities may rise by about 325bn yen next month.
Market watchers blame the yield pickup in these bonds on waning foreign demand, with overseas investors turning net sellers of medium-term JGBs in April for the first time since August, according to data from the Japan Securities Dealers Association.
That’s after the Federal Reserve beefed up its existing dollar-swap lines with major central banks including the BoJ, boosting the supply of the greenback. Fewer Japanese banks are turning to their foreign counterparts to swap yen for dollars, leaving overseas players with little yen to invest in JGBs, said Souichi Takeyama, a rates strategist at SMBC Nikko Securities Inc.
“Unlike the super-long zone, medium-tenor notes lack a solid investor base, raising concern about who would buy as issuances in these sectors increase,” said Yamawaki of JPMorgan. “This puts focus on BoJ’s bond-buying operations.”



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