Pimco Still Bullish as Japan Superlong Bonds Outperform in 2016

  • Fund manager has stuck with super-long debt since October 2014
  • Potential for more BOJ stimulus in second half of year: Pimco

Pacific Investment Management Co. is keeping faith in the Bank of Japan’s bond-buying stimulus, as 2016’s global market panic delivered bumper returns for super-long debt.

Pimco sees further room for longer-maturity sovereign yields to fall toward shorter ones, as the bonds benefit from BOJ stimulus. Governor Haruhiko Kuroda quadrupled purchases of bonds maturing in more than 25 years in October 2014. Debt due in greater than 10 years returned 1.2 percent this year as of Jan. 13 after gaining 2.5 percent last year, according to Bank of America Merrill Lynch indexes. Notes maturing in 10 years or less have returned 0.2 percent this year, after a 0.4 percent gain in 2015.

“Japan’s sovereign yield curve has flattened quickly, but the flattening trend still has more room to go,” Tomoya Masanao, Pimco’s Tokyo-based head of portfolio management for Japan, said in an interview on Jan. 12. “We continue to like an investment strategy that benefits from a continuation of quantitative easing. An overweight position in super-long JGBs looks attractive.”

Yields near zero for bonds with maturities as long as five years have pushed investors and the central bank further along the curve, shrinking the premium offered by 20-year bonds over five-year debt to the least in a year. A global equity selloff spurred by declines in the Chinese yuan and crude oil prices has added to demand, with the benchmark 10-year JGB sinking to a record low Thursday. Kuroda said the same day the BOJ stands ready to take bold action if needed to achieve its 2 percent inflation goal.

Record Low

The 10-year JGB yielded 0.22 percent on Friday in Tokyo, after dipping to a record 0.19 percent the day before.

While a 9.4 percent tumble in the Topix index of Japanese stocks this year and a currency that has strengthened against all its major peers increase the odds of additional stimulus “at the margin,” the central bank is unlikely to act now, according to Masanao.

“The drop in stocks isn’t limited to Japan -- it’s happening globally,” he said. “If only the BOJ acts to spur a rebound, it won’t work. And if it doesn’t work, it’ll actually do a lot more damage.”

Even without an imminent expansion of the central bank’s stimulus, Masanao says tight supply that has already sent yields below what economic fundamentals suggest may push them down even further.

Additional Easing

The government said in December that it plans to reduce annual bond sales for the third year in a row. Operational tweaks to the BOJ’s quantitative easing announced last month will enable the program to continue for longer before reaching technical limits, according to Pimco. The BOJ held a record 30.3 percent of the total debt outstanding as of the end of September.

The more likely timing for additional easing will be the second half of this year, as a sales-tax increase scheduled for April 2017 approaches, prompting the monetary authority to increase purchases of super-long debt, Masanao said. A similar bump in the levy in April 2014 sent the economy into recession.

Analysts are split over whether the central bank will boost stimulus, with a Bloomberg survey last month showing 10 of 25 respondents see action this year, one predicting monetary easing beyond that, and 14 saying the BOJ is done.

High Hurdle

“While we don’t expect an expansion of stimulus, if there’s a rise in speculation of additional easing because of a stronger yen and weaker economic indicators, JGB yields could fall even further,” said Naoya Oshikubo, a rates strategist at Barclays Plc in Tokyo. “The risk of a drop in yields is higher than for an increase.”

Pimco, which had about $1.5 trillion in assets under management worldwide as of Sept. 30, says the main risk for super-long debt would be a total shift in the BOJ’s stimulus framework to negative interest rates, which could cause a steepening of the yield curve. However, Masanao says the “hurdle is very high” for such a change as it would require evidence domestically that QE isn’t working, and proof from Europe that negative rates are effective.

Bond market expectations for inflation in the next decade have dropped to 0.52 percent this week, the lowest in data to October 2013. That’s a level that Masanao said is making investment attractive, and he doesn’t see any immediate threat to bonds from the BOJ achieving its price goal.

Wages in particular have been slow to rise, frustrating Kuroda’s desire for a virtuous cycle of increased demand boosting prices.

“As BOJ Governor Kuroda has told us, the goal of 2 percent consumer price gains isn’t simply about raising the inflation rate, it requires thinking about the balance of the overall economy,” Masanao said. “Three years from the start of Abenomics and quantitative and qualitative easing, what’s clear is how strong the long-term structural headwinds are in the Japanese economy. It probably suggests the limit to reflationary policy.”

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