17 Jan 2023
The Japanese Bond Market
Market forces have pushed Japanese government bond yields above policy targets. The moves are the biggest test in seven years of yield control in Japan
Japan's government bond market is one of the largest in the world, with a total debt value of over $7.9 trillion. However, in recent years, the market has become increasingly illiquid due to a policy known as yield-curve control (YCC) implemented by the Bank of Japan. This policy, which has been in place for the past seven years, aims to stimulate lending, growth, and inflation by keeping short-term interest rates at -0.1% and 10-year yields around zero.
To maintain this interest rate environment, the Bank of Japan has adjusted its tolerance for movement in the 10-year yield several times, most recently in December. As a result, the bank expanded its target band from plus or minus 0.25 to plus or minus 0.5 points. This means that the bank now allows for more significant fluctuation in the 10-year yield, which measures the government's borrowing cost.
As a result of this policy, the Bank of Japan has been forced to buy large quantities of bonds to defend the band's upper limit. This has resulted in the bank owning over half of the government bond market. This significant bond market presence has led to illiquidity and volatility concerns. Additionally, this can harm the market as a whole, as it limits the participation of private investors.
The Bank of Japan's enormous ownership and buying volume has resulted in the government bond market needing more influence in determining benchmark debt prices or the cost of public financing.
According to reports by Keisuke Tsuruta, a fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities, the BOJ's ownership of the 368th series of 10-year Japanese government bonds is nearly total, at 97.0% on January 10th, up from 86.4% on December 22nd. Furthermore, the BOJ held 86.8% of the 367th 10-year bonds on January 10th, an increase from 81.9% on December 20th.
Foreign short-selling has further exacerbated the situation in recent weeks, adding more volatility to an already distorted market. Interest rate swaps, which closely track sovereign bonds in most markets, rose above 1% at the 10-year tenor on Monday. This swap yield may indicate where the 10-year bond would be if the BOJ were to leave the market alone.
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