Kuroda Seen Plotting Return of Yield Curve Drives Bond Rout

Japan Bond Bears Eye 2013 Repeat
  • Spread between 2- and 40-year yields widest since March
  • Kuroda may pare purchases of super-long debt: Goldman’s Baba

Japan’s bonds are reeling from the worst month since at least 2010 on bets policy makers are plotting the return of a long lost friend of banks: the yield curve.

A gauge that tracks notes with maturities longer than 10 years completed the longest losing streak in three years amid concern Governor Haruhiko Kuroda will reduce purchases of such debt after a comprehensive review of monetary policy on Sept. 20-21. Thirty-year government bonds capped their biggest weekly slump since April 2013 after the BOJ refrained from purchasing the securities at its regular market operation on Sept. 2.

The steepening in the curve that plots yields of different maturities will be welcomed by lenders, which often profit from borrowing short-term funds and making longer maturity loans at higher interest rates. Japan’s banking shares rallied more than 20 percent since June 30. Profit margins on loans at Mitsubishi UFJ Financial Group Inc. and its two largest competitors shrank to a record-low 1 percent on average in the quarter started April 1 as yields plunged below zero for notes maturing as far out as 12 years.

“The BOJ is likely to focus on analyzing what factors caused the drop in super-long JGB yields,” said Naohiko Baba, the chief Japan economist at Goldman Sachs Group Inc. and a former BOJ official. “It is expected to cite the amplified impact of the BOJ’s buying operations for these maturities following the introduction of the negative-rate policy, and respond by reducing the amount of its purchase of super-long bonds, while making adjustments in other sectors.”

Policy Focus

While the BOJ is likely to keep the size of its total monthly bond buying plan at 8 to 12 trillion yen ($116 billion), the central bank may adjust the breakdown of the purchases so as to allow a moderate increase in super-long bond yields, according to Goldman’s Baba. The comprehensive review of policy may precede the BOJ gradually placing more emphasis on interest rates instead of quantitative easing, he said.

Toru Suehiro, senior market economist at Mizuho Securities Co. in Tokyo, agreed that the BOJ may choose to adjust the composition of its bond buying operations rather than make a change to monetary policy. The central bank has been trimming its purchases of debt with a maturity longer than 10 years. Monthly buying of the securities dropped to about 1.6 trillion yen in August and July, down from around 2 trillion yen in May and April, and 2.2 trillion yen in January.

Avoid Ripples

“Changes would be moderate as the BOJ likely wants to avoid causing ripples in the market,” Mizuho’s Suehiro said, adding that cuts to long-term bond purchases will likely be in increments of 50 or 100 billion yen. “Markets would eventually settle in the middle of where they used to be before yields spiked and where they are now.”

Twenty-year yields were at 0.405 percent in Tokyo Tuesday, up from a record low of minus 0.005 percent two months ago. Thirty-year yields were at 0.51 percent and 40-year yields traded at 0.595 percent, up from all-time lows of 0.015 percent and 0.045 percent, respectively. The government’s sale of 30-year bonds on Tuesday drew a bid-to-cover ratio of 3.13, up from 3.07 at the previous auction and the highest figure since June 7.

The rapid steepening of Japan’s yield curve is a reversal of its flattening in June, which contracted the spread between 2- and 40-year yields to the smallest since February 2008 as investors sought positive yields.

The Ministry of Finance, which will meet with investors on Thursday to assess demand, may increase 40-year bond sales by 400 billion yen a year on top of an initial plan to issue 1.6 trillion yen in total.

“The BOJ is suggesting it is allowing a rise in yields,”said Souichi Takeyama, a rates strategist at SMBC Nikko Securities Inc. in Tokyo. “A steeper yield curve does ease side-effects for investors. While it’s unlikely the BOJ would change policy to actively prompt steepening, it will try not to let super-long yields decline.”

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