Return of Investors to JGBs, Will the Flattening of the Yield Curve Spill Over?

THE NIKKEI via scoutAsia

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August 17, 2022 5 min read
Return of Investors to JGBs, Will the Flattening of the Yield Curve Spill Over?

The sharp rise in interest rates through June has been reversed, and buying is now taking place in JGBs. This is based on the view that the flattening of the yield curve in the US and Europe due to fears of a global recession will spread to Japan. Foreign bonds hedged against currency risk also have negative yields and are being let go by life insurance companies. The setback of the funds that sold yen bonds is good news for the BOJ, but it is also a side effect of the difficulty of ending deflation.

"In July, we changed our investment decision on Japan's ultra-long-term bonds to bullish." Soufumi Kanemaru, senior portfolio manager at Manulife Investment Management, confides. The reason for this was the belief that the ongoing decline in interest rates in the US and Europe would spread to Japan as fears of a global recession loomed over the market.

Domestic 30-year bond yields rose from about 0.7% at the beginning of the year to about 1.3% in July, an odd level for life insurers and others that have lowered their assumed interest rates below 1%. "The investment decision, which has been "sell," is being hastily tilted to "neutral" Positions betting on "steepening," where the slope of the yield curve tightens, were eliminated," another fund manager at a foreign investment management firm, agrees.

Globally, the yield curve is flattening. The difference between the 2030 and 2-year interest rates is now an "inverse yield cure" with the US at -0.3%, down from about 1.3% at the beginning of the year. Germany also shrank to about 0.6% from a peak of about 1.1% in July. Short-term interest rates, which are easily linked to monetary policy, will rise. On the other hand, the long-term, ultra-long-term rate, which reflects future economic prospects, has lost upward momentum.

Life insurers are also drastically narrowing their holdings of foreign bonds. Life insurers were in a net short position of 1,562.2 billion yen in foreign medium- and long-term bonds in July, according to the Treasury Department's outward and inward securities sales contracts. The net short position amount is the largest ever for a single month.

Why? This is also affected by the flattening of the yield curve. The hedging cost of currency risk is generally the difference between domestic and foreign short-term interest rates. Subtracting the hedging cost of the yen-dollar transaction calculated by QUICK from the yield on the US 30-year bond, the yield sank to a negative 0.04% as of August 15.

It is widely believed that foreign investors' selling attempts were also unsuccessful. "I believe that the BOJ's stance of not changing its policy may have caused foreign investors to withdraw from the market," said Seiji Maruyama, investment operations general manager and CIO of PGIM Japan. The net long position of domestic medium- to long-term bonds by foreign investors reached more than Y5 trillion in July.

On 1st, the BOJ issued a working paper affirming the validity of "Short- and long-term interest rate operations (yield curve control = YCC)." The market takes this as an indication that the BOJ will not easily change its monetary policy after Governor Haruhiko Kuroda steps down in the spring of 2023.

"The current decline in the ultra-long-term rate is simply due to foreign investors moving to short-covering before the summer vacation, and there is room for a reversal after the vacation" (domestic management company), but it appears that they are no longer in the minority.

If the pressure on higher interest rates ceases, it will help the BOJ in the short term to adhere to the YCC. However, the background economic downturn will make the achievement of the inflation target a long way off. The decline in the ultra-long-term rate could be seen as a move to incorporate "It's hard to imagine the BOJ repeatedly raising interest rates" (foreign investment managers) scenario, in which Japan is unable to deflate.

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The English translations provided through this service are the result of automatic and mechanical translation of contents written in Japanese and created by Nikkei or licensed by a third party, by an automatic translation system provided by a third party after certain processing of the contents by Nikkei. Nikkei disclaims all warranties, express or implied, related to the English translations, including any warranty of accuracy, reliability, validity and fitness for a particular purpose. Users shall use this service with the full understanding that it employs an automatic translation system that automatically and mechanically recognizes and analyzes information and outputs the results.