Japan’s Bond Chaos Heralds More Volatility in Global Markets

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Japan’s Bond Chaos Heralds More Volatility in Global Markets.

treasuries & bonds :: 8hrs ago :: source - bloomberg

By Ruth Carson and Masaki Kondo

(Bloomberg) -- Japan’s once-slumbering bond market has roared back to life with a burst of volatility that is echoing around the world.

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Major debt markets have moved in tandem with Japanese government bonds during the recent rout, with a spike in super-long yields in the Asian nation amplifying ructions fueled by global fears of widening fiscal deficits.

The risk of more spillover is on the horizon. An analysis by Bloomberg shows that Treasuries have become more sensitive to moves in Tokyo, just as fluctuations in Japan’s $7.8 trillion debt market soar to the highest level in over two decades.

This is in stark contrast to just a few years ago, when the Bank of Japan’s yield-curve control regime acted as a kind of global anchor on borrowing costs. With that now gone, the broader fixed-income market is finding itself unmoored.

The turmoil has already handed investors in global bonds the first monthly loss for the year as US tariffs and rising government borrowings dented sentiment. In Japan’s case, weakening investor appetite points to even higher yields, increasing a government debt load that is the worst among major economies.

“The rise in Japan bond yields has meaningful spillover impacts globally,” said Freddy Wong, head of Asia Pacific fixed income at Invesco Ltd. which oversees $1.94 trillion. “As JGB yields rise, the relative attractiveness for sovereign bonds in other parts of the world decreases, which drives selloffs and increases volatility in other sovereign debt markets.”

The US debt market has long been exposed to risks from Tokyo, given that Japanese investors are the largest foreign holders of US bonds. But a key turning point came in 2022, when the BOJ started to loosen its grip on bond yields. Treasuries have become steadily more susceptible to changes in JGBs since then, according to Bloomberg’s analysis of 10- to 30-year spreads in both markets.

This change, and the recent spike in volatility in Japan, are reshaping the dynamics of the global day for bond trading. Under yield-curve control that started in 2016, Japan’s market was a world unto itself, with benchmark 10-year securities sometimes going untraded for days. Not anymore. When the market opens in Tokyo at around 9 a.m. local time, investors across Asia and beyond tune in for moves that may flow through to Frankfurt, London and New York.

“You do see this correlation and spillover across global bonds,” said Idanna Appio, portfolio manager at First Eagle Investments, which oversees $152 billion. “When JGB yields move up, then you come in New York time and US Treasury yields start rising.”

A correlation coefficient between Japan’s 30-year bond yields and similar-tenor UK debt climbed to a record high last month, according to data compiled by Bloomberg. A similar gauge between Japanese bonds and Treasuries hit a five-year high.

On one of the most remarkable days of trading in late May in Japan, after a poorly received auction of 20-year bonds sent super-long yields soaring in Tokyo, yields on 30-year Treasuries hit a 19-month high, while the rate on similar-maturity German bunds rose to the highest in two months.

The surge in Japan’s market volatility amplified upward pressure on offshore yields just as President Donald Trump’s signature tax-cut bill fueled concern over US fiscal deficits. The moves were also augmented by waning bets for Federal Reserve interest-rate cuts on signs that inflation might prove stickier than expected.

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“There is likely to be more volatility at the long end of the curve in government bonds since Japan is such a large creditor nation,” said Kathy Jones, chief fixed income strategist at Charles Schwab & Co. in New York. “What happens there is going to have an impact on other developed-market bonds.”

The growing pressure on the long end of the yield curve has fueled calls for the Ministry of Finance to adjust issuance by increasing sales of shorter-maturity securities and trimming offerings of longer-dated ones.

What Bloomberg Strategists Say...

Traders are expressing their views via the BOJ’s rinban operations where they are offering to sell the central bank bigger quantities in short dated debt than longer durations. This shows that investors are expecting Japan’s MOF to tweak debt issuance via an operation twist that skews supply to the near end of the yield curve.

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The volatility has broader ramifications for investors who use bond indexes to set allocations in their portfolios. Japanese government bonds have a 16.7% weighting in the Bloomberg Global Treasury Total Return Index, the highest share after US debt. That means a sharp drop in the value of Japan’s bonds can result in investors nursing losses worldwide.

“The significant weight means ructions in the JGB market will directly impact funds that track benchmarks, including losses for global bond investors,” said TD Securities strategist Prashant Newnaha, who has covered debt markets for 25 years.

All this is happening while the Bank of Japan is also scaling back its debt purchases after years of snapping up bonds. The monetary authority owns more than half of all outstanding sovereign notes, and large institutional investors have not stepped in to fill the gap left by the reduction of the central bank’s purchases.

The BOJ’s holdings of JGBs fell ¥6.18 trillion ($43 billion) in the first quarter, the biggest-ever drop according to data going back to 1996, as it slowed purchases and existing debt matured. Following the recent market turmoil, the BOJ is likely to consider slowing the pullback from April next year, according to people familiar with the matter. An announcement on this may come at the conclusion of a two-day policy meeting on Tuesday.

The benchmark 10-year yield rose 4.5 basis points to 1.445% on Monday after falling in the past three weeks. The 30-year yield gained 2 basis points to 2.900%.

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The surge in volatility has been particularly acute in bonds due in more than 10 years, Bloomberg’s analysis shows. A draft of the government’s annual fiscal policy plan emphasized the need to increase the domestic buying of government bonds to help curb further yield increases.

“There has been a global distaste for ultra-long duration due to inflationary concerns and now Japan is in the spotlight — with repercussions around the world,” said Calvin Yeoh, portfolio manager at hedge fund Blue Edge Advisors.

Despite all the risks, some say the pessimism is overdone and that calm will return to Japan’s bond market.

Pacific Investment Management Co., which oversees more than $2 trillion in assets, said the recent selloff in JGBs was driven by technical factors and policymakers have the tools to address the risks. The spike in yields has boosted the bonds’ appeal, with 30-year JGBs hedged to the US dollar yielding over 7%, co-head of Asia-Pacific portfolio management Tomoya Masanao and portfolio manager Ryota Kawai wrote in a report.

Pictet Asset Management’s Patrick Zweifel noted that Japan’s debt repayment ability remains sound, and that while long-term yields are rising sharply, “this won’t lead to an uncontrollable increase in debt costs.”

Even so, market watchers are mindful of several risks that may complicate the outlook in the coming months.

For one, the BOJ still plans to reduce its debt purchases by another 29% by end-March next year from ¥4.1 trillion this month, potentially resulting in slack in demand that may fuel more volatility.

On the global front, Trump’s policies on trade and tax cuts are fanning fears about inflation, as well as an increase in government borrowings to bolster growth. All this is likely to exacerbate the swings in Japanese bonds and generate a corresponding move in other debt markets.

“There is no proof that the 30-year yield has peaked,” said Shoichi Tokuoka, chief fund manager and chief economist at Mitsubishi UFJ Asset Management. “It could go higher as inflation is becoming sticky. Ultra-long bond yields are prone to further rises globally.”

--With assistance from Mia Glass and Hideyuki Sano.

(Adds Monday’s yield moves in the 19th paragraph.)