By Kevin Buckland and Shigeki Nozawa
In Japan, the yield hunters have become the hunted.
Investors who refused to swallow negative yields to hold Japan’s shorter-dated bonds are suffering, as an index of sovereign debt maturing in 20 years or more has lost 9 percent this quarter. The yield on 2036 bonds climbed to the highest since March 16 as BOJ Governor Haruhiko Kuroda noted last week that low long-term yields hurt returns on pension and insurance investments, even as he signaled there would be no reduction in easing with a policy review due Sept. 21. A 20-year debt sale Tuesday drew the lowest demand in six months.
“JGBs are responding unreservedly to the BOJ’s message that it’s not desirable for superlong yields to be too low,” said Takafumi Yamawaki, the chief rates strategist in Tokyo at JPMorgan Chase & Co. “The problem is we don’t know what the BOJ’s desired level is, and that’s created an atmosphere of paranoia in the market.”
The intensity of Japan’s bond selloff has sparked concern the market will become the epicenter for a global rout, just as it led a record rally in the first half of 2016. Federal Reserve officials are cautioning against waiting too long to tighten policy, while the European Central Bank is playing down the prospect of further stimulus. DoubleLine Capital Chief Investment Officer Jeffrey Gundlach is among those recommending investors prepare for bonds to fall.
Speculation the BOJ will cut or otherwise limit purchases of superlong debt as soon as its meeting next week pushed the spread between two- and 30-year yields, a measure of the steepness of the yield curve, to as wide as 81 basis points for the first time since March 17. The gap was at an unprecedented 33 basis points on June 29.
Thirty-year bond yields rose to an almost six-month high of 0.565 percent on Monday in Tokyo, before retreating to 0.515 percent on Tuesday. They have lost about 12 percent on a total-return basis since the yield reached a record-low 0.015 percent on July 6, according to Bloomberg calculations. Forty-year yields touched 0.62 percent, the highest since March 17. Two-year notes are little changed over the period, and were at minus 0.245 percent from their all-time low of minus 0.37 percent.
Twenty-year yields advanced as high as 0.475 percent Monday, from a record minus 0.005 percent touched in July. They were at 0.44 percent Tuesday, after an auction of the tenor generated a bid-to-cover ratio of 3.33, the lowest since the sale on March 17. The bonds have been a bastion for domestic investors seeking to balance returns and liquidity.
“This is a big, big moment,” DoubleLine’s Gundlach said in a webcast Thursday. “Interest rates have bottomed. They may not rise in the near term as I’ve talked about for years. But I think it’s the beginning of something and you’re supposed to be defensive.”
There has been speculation about the limit to Kuroda’s quantitative-easing program since its inception in April 2013. In March of this year, record-low participation at a BOJ operation to buy long-term debt reignited concern about a lack of supply. The unexpected announcement of a comprehensive review after the July policy meeting invigorated the debate.
Investors told Ministry of Finance officials at a regular meeting this month that they would like increased issuance of 20- and 30-year bonds. They also said that while yields had risen somewhat, they were not high enough.
The BOJ has only bought superlong debt in its asset-purchase operations once this month, and surprised markets by forgoing the maturities on Sept. 2, feeding theories it will pursue a policy to steepen the yield curve.
Morgan Stanley is less convinced, but says it’s not willing to fight the consensus for now.
“Investors in Japan wholeheartedly believe that the Bank of Japan wants a steeper yield curve,” analysts led by Matthew Hornbach wrote in a client note. “Perception has become reality.”