Bond Respite Spurs Demand for Japan's Best-Performing Debt

  • Twenty-year bonds offer best roll-and-carry amid curve control
  • Global yields seen staying little changed for coming month

Peace, or at least a truce, seems to have broken out in the global bond market and Japanese investors see that as a signal to buy more of the only maturities to make any significant money this year: 20-year notes.

The Bank of Japan fought off the impact of the global bond rout by ramping up its interventions in the local debt market and halting a spike in benchmark 10-year yields. The turmoil highlighted the way in which policy makers’ commitment to holding the benchmark yield near zero makes the BOJ and Japanese investors vulnerable when other major central banks shift to a hawkish stance.

The BOJ responded last month by offering to buy unlimited amounts of 10-year debt at 0.11 percent -- even though no one sold them at that rate the level is now seen as a cap for yields; it also acts as an anchor for 20-year notes. That means the central bank has created a bout of low bond volatility that will likely set off a hunt for carry income, said Koichi Sugisaki, a strategist with Morgan Stanley MUFG Securities Co. 

“The game of chicken may begin, as the most popular strategy would be buying the dip for the 20-year sector, where carry- and roll-down income is high,” he said, referring to strategies where investors seek to hold onto notes for coupon payments and then sell them for capital gain when yields fall. “Investors are wary about chasing down yields, so we will likely see them buy when yields get above 0.6 percent and sell when yields fall toward 0.5 percent. Volatility will be suppressed.”

The bond sell-off triggered early in July by speculation the European Central Bank would consider tapering drove German yields to 18-month highs, lifting those on Treasuries and boosting 10-year Japanese rates above 0.1 percent. There’s a risk of further bond pain when global central bankers gather at a Jackson Hole meeting hosted by the Federal Reserve Aug. 24-26. The ECB then meets on Sept. 7 and U.S. policy makers may announce a reduction of its balance sheet on Sept. 21.

The only bonds in the Bloomberg Barclays Asian-Pacific Japan Treasury Total Return Index to generate returns above 0.1 percent this year are ones with maturities from 15 to 20 years. The index itself has declined 0.3 percent in 2017.  

“Until Jackson Hole and ECB’s September meeting, the overseas market impact on JGB yields will be limited,” said Satoshi Shimamura, head of rates and markets for the investment strategy department at MassMutual Life Insurance Co. in Tokyo. “After these events, speculation could grow about whether the BOJ can remain inactive if the ECB takes steps toward tapering, putting pressure on the Japanese central bank.”

The 10-year JGB yield has fallen from the July peak of 0.105 percent to 0.065 percent. The BOJ’s cap on the benchmark also sent two- and five-year yields back deeper into the negative. Super-long bond yields stayed high amid market expectations that the central bank will tolerate their climb as long as it doesn’t push up 10-year yields.

The spread between 10- and 20-year JGBs is about 50 basis points, more than double the spread in the maturities under the BOJ’s control, highlighting the 20-year sector’s appeal, said Takenobu Nakashima, quantitative strategist at Nomura Securities Co. in Tokyo.

The Bank of Japan kept bond purchases unchanged Friday from its previous operation. Twenty-year yields were steady at 0.575 percent, while 30-years held at 0.87 percent.

Curve Play

The late summer lull should be good for maturities longer than 10 years, where the influence of the BOJ -- which owns about 40 percent of all JGBs -- is felt much less, according to Shinji Kunibe, the Tokyo-based head of fixed-income at Daiwa SB Investments Ltd. He also picked out the 20-year notes as offering value amid extremely low volatility.

“Markets will likely be calm until the Fed and the ECB start announcing details about their balance sheet adjustments, which would unsettle JGBs particularly in super-long maturities,” Kunibe said. “With calm overseas, investors would naturally prefer 15- to 20-year zones where carry- and roll-down income is attractive.” 

Investors could wait to buy 30-year bonds as their yield could soar about 15 basis points to above 1 percent in this low-volatility environment when overseas borrowing costs rise in response to tapering talks, Kunibe said.

The respite offered means the BOJ can afford to maintain the range of bond purchases for its regular operations in August, unchanged from July. Governor Haruhiko Kuroda kept the central bank’s monetary stimulus program at its latest policy meeting on July 20, though policy makers pushed back the projected timing for reaching a 2 percent inflation target.

“For now, the BOJ can conduct market operations without pressure to forcibly contain yields,” said Akio Kato, general manager of trading at Mitsubishi UFJ Kokusai Asset Management Co. in Tokyo.

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