Photographer: Tomohiro Ohsumi

There's Been a 'Quiet Riot' in Japanese Government Bonds

A potential watershed moment as investors turn their attention from monetary to fiscal policies.

Investors have been stealthily shedding Japanese government bonds, pushing yields on the benchmark 10-year security to their highest in almost six months.

JGBs have recorded their worst monthly performance since 2010 with longer-dated debt under particular pressure as investors fret that Bank of Japan Governor Haruhiko Kuroda will further reduce debt purchases following a comprehensive review of monetary policy on Sept. 20-21.

A gauge that tracks notes with maturities of more than 10 years posted its longest losing streak since 2013, but the "quiet riot" is also spreading to shorter-dated debt, according to analysts at Jefferies Group LLC, with the 10-year yield breaking through a series of moving averages in recent days.

The sell-off in JGBs may prove significant for wider financial markets given the propensity of deep-pocketed Japanese investors including banks, insurers, and pension funds, to affect other asset classes ranging from corporate bonds to global equities. But the sell-off could also mark a milestone in which markets pin their hopes less on the Bank of Japan's unconventional monetary policy — including quantitative easing and experiments with negative deposit rates — and more on government-led measures.

"The turnaround in JGB yields has been independent of the recent retreat in the yen cross rate and suggests that the bond markets are beginning to discount no further negative deposit rate cuts as well as potentially longer duration JGB primary sales ahead of this month’s BOJ meeting," Jefferies analysts led by Sean Darby wrote in a note published today. "A more sinister view of the reversal in JGB prices is that the markets have begun to realize that the 'frontier' in QE policies is drawing to a close. In particular, there is the growing reality that the BOJ may be set to taper JGB purchases at the forthcoming BOJ meeting."

Investors may be expecting the BOJ to attempt to attempt to fan inflation through new fiscal measures, including an "income and wages" policy that would force Japanese corporations to increase workers' pay, Jefferies said.

Such a move would "entail a more government-led approach to exiting deflation than necessarily an entirely monetary one," concluded Darby. "The bottom line is that the earlier 'bond market sell-off' following the August BOJ meeting is turning into a 'mini' bond market rout. It remains to be seen whether the August BOJ meeting or the forthcoming BOJ meeting proved to be the watershed for JGB bonds."

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