Investors can pick up bargains in Japanese government bonds despite a wave of recent selling that has spread volatility throughout global debt markets, according to Pacific Investment Management Co.
The bond fund manager, which oversees over US$2 trillion ($2.58 trillion) in assets, has released a report on the recent volatility in Japan’s bond market. One surprising conclusion: The possibility of more quantitative tightening by the Bank of Japan could be a good thing for JGBs, since it will relieve pressure on the long-end of the curve, where the central bank is less active.
Pimco’s vote of confidence in the market will give reassurance to other investors, given the firm’s clout in global fixed-income. Japan’s once sleepy debt market has taken a starring role in recent turmoil, turning the country’s government bond auctions into closely-watched barometers of stress — with the potential to spread volatility from Australia to the US.
“While higher volatility is likely to continue, we believe that JGB valuations could be attractive for foreign investors seeking yield and diversification in global fixed income,” wrote co-head of Asia-Pacific portfolio management Tomoya Masanao, portfolio manager Ryota Kawai and economist Allison Boxer in a note.
Japan’s 10-year yields were around 1.50% on Wednesday, slightly higher on the day.
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Supply and demand
Part of Pimco’s argument is that Japanese policymakers have the tools to deal with supply and demand imbalances in the market, which have been exacerbated by dwindling long-term bond buying by life insurance companies and the BOJ’s huge investments in shorter-term notes.
The Ministry of Finance could more actively manage its issuance at shorter intervals, perhaps on a quarterly basis, the Pimco team wrote. That would give it more flexibility than the current system of fixing an annual issuance plan in advance.
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They also said that a continued reduction of bond investment by the BOJ, through quantitative tightening, could relieve pressure on longer-term yields. This is because the central bank tends to concentrate its purchases on the short-end of the market, meaning longer-term bonds take the brunt of volatility.
“The BOJ’s share of shorter-dated JGBs has made the long end an escape valve for any rise in the term premium,” they wrote. “If the BOJ continues to reduce its JGB holdings, typical market mechanisms could return to the rest of the yield curve.”
The BOJ has been gradually reducing its massive balance sheet and scaling back on bond purchases, fueling questions about which investors can fill up the missing demand. On May 20, a sale for 20-year notes fizzled out with demand at its weakest in more than a decade. The auction of 40-year bonds on May 28 was met with the weakest demand in 10 months.
But although swings in yields and disappointing auctions have rattled nerves, Pimco’s team wrote that much of the volatility in Japan’s US$7.8 trillion bond market appears to be driven by technical factors. They pointed to the eye-catching returns investors can now get on Japanese debt as a reason to look past these factors and load up on bonds.
“For foreign investors accustomed to the pre-pandemic era of low or negative yields on JGBs, the current environment is striking: 30-year JGBs hedged to the US dollar now yield over 7%,” they wrote. “Interest rate risk in Japan may indeed be a component of an attractive allocation to duration globally – a significant change from the pre-pandemic decade.”
