Japan's Bond Market Is Close to Breaking Point

Bank Of Japan Governor Haruhiko Kuroda News Conference

Haruhiko Kuroda, governor of the Bank of Japan.

Photographer: Kiyoshi Ota/Bloomberg
  • Inverted curve, rising volatility, thin trading among risks
  • `We hold a lot, and we’re not selling': Fukoku Mutual Life

Signs of stress are multiplying in Japan’s government bond market, which is crumbling under pressure from the central bank’s unprecedented asset-purchase program and negative interest rates.

Bank of Japan Governor Haruhiko Kuroda has repeatedly said his policies are having the desired effect on markets, including suppressing JGB yields. His success is driving frenzied demand for longer-dated notes as investors avoid the negative yields offered on maturities up to 10 years. And as buyers hang on to debt offering interest returns, the BOJ is finding it harder to press on with bond purchases of as much as 12 trillion yen ($106 billion) a month, sparking sudden price swings leading to yield curve inversions that have nothing to do with economic fundamentals.

“We hold a lot, and we’re not selling,” said Yoshiyuki Suzuki, the head of fixed income in Tokyo at Fukoku Mutual Life Insurance, which has $59 billion in assets. “We can get interest income. If we sell, there are no good alternatives.”

The following charts show signs of stress in the market:

Yields on 40-year JGBs dipped below those on 30-year securities Tuesday, and a BOJ operation to buy long-term notes last week met the lowest investor participation on record. Bond market functionality has deteriorated, with 41 percent of respondents last month rating it as “low,” the highest proportion since the BOJ began the quarterly survey more than a year ago.

“It wouldn’t be surprising to see some BOJ operations fail,” said Yusuke Ikawa, a salesperson at UBS Group AG’s Knowledge Network in Tokyo. “The biggest risk of that is in superlong bonds.”

A dearth of liquidity has driven a measure of bond-market fluctuations to levels unseen since 1999.

“The market has gone from having extremely high liquidity previously, to the point where trading by investors can easily show up as volatility in yields,” said Tatsuya Higuchi, chief fund manager in the fixed income investment division at Mitsubishi UFJ Kokusai Asset Management Co. “There is a negative side to the BOJ’s bond buying.”

Demand for JGBs has increased so much since the start of negative-rate policy that it’s flipped the market for repurchase agreements on its head: Dealers who in normal circumstances would pay to borrow overnight cash in the repo market -- offering debt as surety of repayment -- are instead willing to pay to get access to the collateral.

Distortions in the market are poised to become even more pronounced, with almost 90 percent of analysts in Bloomberg’s most-recent survey predicting additional stimulus by the end of July.

The BOJ has already cornered close to a third of the JGB market, more than any other class of investor. That proportion will grow as asset purchases continue -- even without an expansion of easing.

The central bank is also buying negative-yielding bonds in the market, which has an overwhelming majority of the world’s sub-zero debt. The benchmark 10-year JGB yielded minus 0.09 percent on Thursday, after plunging to a record low of minus 0.135 percent on March 18. Positive yields on 40- and 30-year debt jumped about 10 basis points after the BOJ reduced the size of an operation to buy long-term bonds.

The market disruptions raise concerns that the BOJ is nearing the limits of its stimulus, even as Kuroda has said the central bank can do more. There are also questions over whether, if the central bank is forced to exit prematurely, the market can withstand the potential shock.

“How can the BOJ head for the exit?” Dan Fuss, vice chairman of Loomis Sayles & Co., said at an event in Tokyo last week. “If they open the exit door, there’s a fire on the other side.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE