Pimco Says Japan Long Bond Rally Probably Over as Prices Plunge

  • Ten-year bonds suffer biggest rout since May 2013 on Tuesday
  • BOJ balance sheet rises to $4.26 trillion, rivaling the Fed’s

BOE's Rate Balancing Act for Avoiding a Recession

Pacific Investment Management Co. says a record-setting rally in long-term Japanese government bonds has likely run its course because the central bank has pushed monetary policy as far as it can. Bonds fell Tuesday by the most in three years.

“We have probably seen the low of the yield of the super long JGBs,” Tomoya Masanao, Pimco’s head of portfolio management in Japan, wrote in an e-mail Monday. “The BOJ hit its limit,” he wrote in a report on the company’s website last week.

The BOJ’s balance sheet has ballooned to $4.26 trillion, growing 50 percent in a year in dollar terms as it gobbles up government debt and other assets. For the Federal Reserve, the figure has held at about $4.46 trillion. Japanese policy makers fueled speculation they’re running out of options when they finished a meeting last week and opted against extending their two main tools -- bond purchases and negative interest rates -- even as the inflation rate falls further below zero.

Officials signaled it’s time for a rethink by announcing they’re preparing a “comprehensive” assessment for the September meeting.

The comment helped send bonds into a three-day tailspin, driving benchmark 10-year yields up almost a quarter point. The selloff picked up Tuesday after demand fell at a 10-year auction. The 10-year yield advanced 9 1/2 basis points to minus 0.05 percent as of 1:43 p.m. in Tokyo, the biggest increase since May 2013.

The BOJ buys 8 trillion yen ($78 billion) to 12 trillion yen of debt per month, enough to take up every new bond the government sells. The central bank now owns a third of the market, based on its own data. Policy makers are trying to end two decades of deflation by pushing down bond yields, the benchmarks for lending rates, with the aim of encouraging people to borrow.

For more on the BOJ’s policy review, click here.

Bonds due in a decade and longer have returned almost 20 percent in the past year as a result, based on the Bloomberg World Bond Indexes. Benchmark 10-year yields fell as low as minus 0.3 percent last month, while 30-year yields plunged to 1.5 basis points, both records.

Monthly Loss

Now those gains are in jeopardy as investors question what more the central bank can do. Long-term bonds fell 2 percent in July, the first monthly loss in more than a year.

Kuroda addressed investors’ concerns at a press conference last week, denying the BOJ has reached a limit, and he increased the amount of stock exchange-traded funds the central bank buys. He repeated he won’t hesitate to act if needed through further easing, adding there is room to lower the negative interest rate further. 

Pimco’s Masanao said the BOJ’s decision not to use bond purchases and interest rates this time suggests it has “implicitly admitted” its policies pushed yields too low. “The costs to the financial institutions and hence the costs to the real economy have increased,” he wrote in his e-mail. In his website report, he explained that bank margins get squeezed as reinvestment yield declines while liability costs, or promised returns, cannot be lowered.

Correct Prediction

Officials will probably adjust the amount of debt they buy and their negative interest rate at their September meeting, Masanao said in his e-mail. The Tokyo-based investor, one of the managers for the $1.51 trillion of assets at Pimco, in January correctly predicted this year’s rally.

Even before last week’s meeting, analysts were saying the BOJ may start cutting its purchases.

“They are aware they are nearing the limit, whether that is now or later,” Kazuo Momma, who worked at the BOJ until the end of May, said last month. "Based on common sense, you’d think they’d start considering reducing the pace a little bit in the near future.”

The BOJ will remain a supportive force for JGBs, said Glenn Maguire, chief economist for Asia and the Pacific at Australia & New Zealand Banking Group Ltd.

“Why would they want to sell and keep perpetuating a selloff?" Maguire said in an interview in Singapore. “The sheer size and bulk of their participation in the market is going to be a stabilizer.”

The surge in the BOJ’s assets to almost the same level as the Fed’s is a sign Kuroda will have trouble extending his policy program, said Naruki Nakamura, the head of fixed income at BNP Paribas Investment Partners Japan in Tokyo.

“I’m cautious on the market because the BOJ policy is currently hitting the wall,” Nakamura said. “It is almost impossible to continue this trend, to increase the balance sheet and maybe go over the Fed.” His firm manages or advises on $582 billion worldwide.

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