Japan's quick-fix for bond markets sets a global test case

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7 days ago

By Vidya Ranganathan and Carolina Mandl
SINGAPORE/NEW YORK (Reuters) -Japan, one of the world's most indebted developed economies, this week also turned into a saviour of sorts for its own bond market and globally.
When Reuters reported on Tuesday Japan's ministry of finance (MOF) may reduce issuance of super-long tenor debt, bond markets from Japan and South Korea to Britain and the United States reacted positively, pushing prices up and yields down.
That paused the weeks-long bond selloff forced by investors demanding bigger yields as they braced for increased inflation and government spending caused by U.S. President Donald Trump's trade and tax policies.
Yields on 40-year Japanese government bonds (JGBs) had hit a record high 3.675% last week and were down 40 basis points from that level. Yields on 30-year U.S. Treasuries dropped to below a key 5% figure, helping the yield curve turn less steep.
Michael Lorizio, managing director and head of U.S. rates at Manulife Investment Management, said Japan's proposal had stabilised all developed government debt.
"As deficits expand, this will be a test case for other countries, if being more flexible around how issuance is scheduled is an attractive option, or not."
Japan would be a test case for the entire world on the best way for governments to handle "signs of stress or a mismatch between supply and demand," Lorizio said.
As of Wednesday, going by the auction of 40-year JGBs, investors aren't sold on the idea. Demand at the auction was at its weakest since July. A week ago, investors eschewed a 20-year bond auction so badly it was Japan's worst auction result since 2012.
"For now, we have more orderly markets and some time for markets to catch their breath but, in the big picture, it's a band-aid," said Tom Nakamura, vice-president and head of fixed income & currencies at Canadian fund AGF Investments.
"All these things are meant to help market functioning in the short term, but do very little to alleviate concerns in the medium- to long-term because the underlying causes of those concerns haven't gone away and are not helped by increasing funding from shorter-term instruments," he said.
Nakamura said his portfolio has changed to limit exposure to long-end bonds and diversify into markets with healthier fiscal settings or more attractive yields, such as Germany, Poland and Romania.
RECOGNISING RISKS
Japan isn't alone. Britain's debt agency told Reuters in March there would be an "important shift" away from long-dated debt in the coming financial year in response to rising borrowing costs and reduced investor demand.
Britain plans to issue 299 billion pounds ($402.60 billion of government bonds this year - the second highest amount on record - and its bonds have come under pressure from concern about high debt levels and bond issuance.
Japan's situation is more complicated than elsewhere as its debt is 2-1/2 times the size of the economy and its central bank has slashed its previous bond buying.
That governments are retooling their debt and fund-raising plans shows they are listening to markets, rather than letting central banks manage yields through monetary tools, analysts said.
"What surprised us as well as the market was that we didn't really expect the Ministry of Finance to be the one that moves and starts discussing changes in issuance," said Subadra Rajappa, head of U.S. rates strategy at Societe Generale.
While the U.S. Treasury has for years gradually shortened the duration of its debt by issuing more short-term bills as longer term bonds mature, overall debt has been rising.
If Trump's "big, beautiful bill" on taxes is passed in the coming days, it is estimated to add about $3.8 trillion to the federal government's $36.2 trillion in debt over the next decade.
When Moody's Investors' Service downgraded the U.S. rating this month, it projected U.S. public debt, now around 100% of gross domestic product, will rise to 134% over the next decade.
"The Treasury is finding that the market doesn't have an appetite for anything at the long end of the curve unless the rate is above 5%," said Eric Beyrich, co-chief investment officer at Sound Income Strategies. "That will force them back to the short end of the curve when it comes to new issues."
Germany is the only G7 economy with a debt-to-GDP ratio below 100%, yet investors have also sold its bonds in recent months on expectations of more supply following the surprise creation of a 500 billion euro ($565 billion) infrastructure fund.
"The market is sending a signal that concerns are growing around fiscal and debt sustainability," said Chip Hughey, managing director of fixed income at Truist Advisory Services in Richmond, Virginia.
"Market participants want to see policymakers use a multi-pronged approach to address deficits and lower their reliance on debt issuance."
($1 = 0.8846 euros)
($1 = 0.7427 pounds)