Investors are bracing for the largest supply of Japanese sovereign bonds in over a decade, as the Bank of Japan (BOJ) plans to significantly reduce its bond purchases and shrink its balance sheet. Combined with rising interest rates, this shift could deepen challenges for debt holders.
The Ministry of Finance is expected to announce its annual debt issuance plan in late December for the fiscal year starting April 1. If the plan mirrors the current fiscal year, bond supply could surge by 64% to ¥61 trillion ($390 billion), factoring in redemptions and reduced BOJ purchases, according to a Bloomberg analysis.
BOJ’s Balance Sheet Reduction Intensifies Pressure
The BOJ plans to nearly halve its bond purchases from July 2024 to March 2026, which would result in its holdings shrinking by ¥37.6 trillion next fiscal year. This reduction coincides with expectations of further interest rate hikes aimed at controlling inflation. Compounding the situation, Prime Minister Shigeru Ishiba’s additional spending initiatives—meant to bolster his waning popularity—could further strain bond markets.
“The current pace of the BOJ’s purchase cut is severely impacting the market’s supply-demand balance,” said Eiji Dohke, chief bond strategist at SBI Securities Co. He suggested the central bank might need to slow the pace of reductions, especially if the Ishiba administration pursues populist fiscal measures that necessitate increased bond issuance.
BOJ’s Role in Market Dynamics
The BOJ’s influence over Japan’s debt market remains significant, with the central bank owning more than half of government bonds as of November. Governor Kazuo Ueda has projected a gradual reduction in holdings, aiming for a 7-8% decrease over two years. However, these holdings are expected to remain elevated in the long term.
Ueda recently signaled a cautious approach to rate hikes, citing the need for more data on domestic wage trends and the potential policy direction of U.S. President-elect Donald Trump.
Market Outlook: Divergent Views
Not all market participants are alarmed by the prospect of increased bond supply. Makoto Suzuki, senior bond strategist at Okasan Securities, noted that the impact might be limited, with super-long bond issuance expected to decline. The market could have sufficient capacity to absorb an increase in short- to intermediate-term debt, potentially preventing yields from falling too sharply under certain conditions.
However, the bearish sentiment toward Japanese government bonds persists. The securities have fallen more than 2% since the start of the fiscal year and are on track for an unprecedented sixth consecutive year of losses. The benchmark 10-year yield, currently around 1%, is projected to rise to 1.32% by March 2026, according to a BOJ survey of financial institutions.
Rising Yields and Market Implications
The BOJ’s scaling back of purchases is expected to exacerbate upward pressure on yields. “Yields risk rising as the supply-demand balance worsens in the bond market,” said Makoto Yamashita, chief economist at the Shinkumi Federation Bank.
Higher yields could reduce investor demand for bonds, as fewer purchases are needed to generate desired returns. This dynamic could further amplify the challenges facing the bond market, reinforcing the cycle of rising yields and reduced demand.
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