The Zhitong Finance App learned that since the market generally expects the Bank of Japan to keep interest rates unchanged when announcing the interest rate decision on Friday, high yields have attracted investors, and demand for Japanese 2-year government bond auctions is strong. According to reports, the bid multiplier for this auction was 4.03 times, the highest since June. It is 3.89 times higher than the previous auction, and also higher than the average of 3.84 times over the past 12 months. Another sign of strong investor interest is that the “tail margin” (that is, the gap between the average winning bid price and the lowest bid price) of this auction was 0.014, the same as last month's auction.
Since 2-year treasury yields are sensitive to monetary policy expectations, investors are paying close attention to this type of maturity. Affected by the sell-off of global bonds last month, the yield on Japan's 2-year treasury bonds once rose to the highest level in decades, then declined slightly.
Ryutaro Kimura, a senior bond strategist at Paris Asset Management, said that the French debt problem continues to raise concerns. Coupled with uncertainty about the future of artificial intelligence (AI) related stocks, investors' demand for safe-haven assets continues to exist, thus supporting the stable results of this auction.
He added: “On the other hand, tomorrow's Bank of Japan meeting may raise its assessment of potential inflation in a statement, which may further confirm the Bank of Japan's position to raise interest rates faster and reach a neutral interest rate level as soon as possible.”
Overnight index swaps show that the probability that the Bank of Japan will raise interest rates before the current December meeting in the market is about 84%. Japan's potential inflation index soared to the highest level in three years in September, further supporting the Japanese authorities' reasons for continuing to raise interest rates.
The Bank of Japan is likely to maintain a relatively rapid pace of interest rate hikes because the current price trend is still the same. At the same time, the Bank of Japan believes that up to now, the impact of interest rate hikes on the economy is still limited. According to people familiar with the matter. Traders will keep a close eye on Bank of Japan Governor Ueda Kazuo's press conference after the interest rate decision on Friday to find signals about the speed and space for further policy tightening in the future.
Markets Live strategist Mark Cranfield said, “Today's demand for 2-year Japanese treasury bonds auctions is strong, higher than the average for the past year, which shows that bond traders seem to believe that the Bank of Japan will not adjust interest rates on Friday. This gave investors more time to continue to enjoy the downward effects of the yield curve before the December monetary policy meeting. The weak performance of the 2-year treasury bond auction in August looks more and more like an abnormal event in the Japanese treasury bond auction calendar.”
Meanwhile, the strategist pointed out that Mitsubishi UFJ Financial Group - Morgan Stanley (MUFJ-MS) is the biggest buyer, which is a positive sign for secondary market transactions. Furthermore, the identity of about 61% of buyers is unknown, which also suggests that long-term portfolio investors may be providing support.
It is worth mentioning that global fund managers are once again showing interest in the Japanese bond market as signs of a recovery in domestic demand in Japan and a more favorable policy environment enhances the appeal of high yields. T. Rowe Price Group Inc. cut its exposure to Japanese government bonds earlier this year and now favors longer-term bonds. Allianz Global Investments (which is selectively increasing its holdings of medium- and long-term bonds, while BNP Paribas Asset Management) has established ultra-long-term bond exposure.
This shift in attitude is in stark contrast to earlier this year. Previously, even higher yields were not enough to dispel investors' concerns: the market feared that the Bank of Japan's interest rate hikes would be slow, fiscal spending would push up the supply of treasury bonds, and traditional local buyers continued to wait and see. Now, the market expects that the Bank of Japan will continue to raise interest rates, insurance institutions will re-enter the market to buy bonds, and fund managers will be more emboldened to seize current high-yield opportunities.
T. Rowe Price portfolio manager Vincent Chung is currently optimistic about long-term bonds and is betting that the yield curve will flatten in an environment where the Bank of Japan raises interest rates. This marks a shift from earlier this year — when he bought Japanese treasury bonds in January (which had been undervalued for the previous year) and cut his exposure just a month later due to heightened fiscal concerns.
Vincent Chung now believes that supply and demand will be more balanced before the end of the year, thanks to recent retail purchases and the prospect of additional demand if proposed tax incentives are introduced. Potential changes in the allocation of the Japanese Government Pension Investment Fund (GPIF) may provide another source of support, but he said any decision will depend in part on global market performance.
The financial test
Fiscal policy remains the biggest obstacle to a further continuous rebound in the bond market. The 2027 treasury bond issuance plan will test the bond market sentiment that has just picked up. Investors are closely watching how the Japanese government is raising funds for food consumption tax relief and defense spending expansion.
Vincent Chung said that if the budget plan fails to clarify the source of funding, the logic of betting that the curve is flattening will be at risk. Shoki Omori, chief Japanese fixed income strategist at Deutsche Securities, warned that if a larger supplementary budget is introduced or the bond issuance plan fails to further reduce the supply of ultra-long-term treasury bonds, the recent narrowing of interest spreads on long-term bonds may be reversed.
Brandywine Global Investment Management cut its exposure to Japanese treasury bonds and sold its 30-year holdings earlier this year, and has yet to buy it again. Portfolio manager Carol Lye said that Takaichi Sanae's cabinet downplay of re-inflation will help stabilize yields, but investors are still waiting for a credible funding plan. As the 10-year yield falls below 3%, she also believes there is a possibility that demand will slow down.
The Bank of Japan will provide another test at Friday's policy meeting. Officials generally expect interest rates to remain unchanged, and investors will focus on Governor Ueda Kazuo's guidance on the pace of austerity and how far interest rates are from their final peak.
James McAlevey, head of global comprehensive and absolute returns at BNP Paribas Asset Management, believes that further boosting confidence requires a “relatively restrained fiscal response” from the government and continued austerity of the Bank of Japan. He said that the central bank doesn't necessarily need to raise interest rates this week, but the December action and continued “relatively hawkish” communication are enough.