Bank of Japan operations trigger rare bond market anomaly

Investors are becoming anxious to reduce their holdings of Japanese government bonds, and a good percentage prefer to sell the securities at a discount to the central bank.

During the Bank of Japan’s regularly scheduled bond buying operation on Aug. 14 and Aug. 20, something unusual occurred: the operations’ lowest accepted yield matched the accepted average.

This is rare because bondholders typically aim to sell at the highest price, which pushes yields lower. In this case, however, the lowest yield rose to meet the average, suggesting some investors offered bonds at bargain prices. Analysts say a few large-scale sales of ¥350 billion ($2.4 billion) of domestic sovereign debt with five- to ten-year maturities filled the purchase quota, forcing other sellers to offload debt in the secondary market.

The last time such an anomaly occurred was a decade ago, just before long-term yields fell below zero as the BOJ implemented radical monetary easing to pull the economy out of deflation. This month marked the first back-to-back merger of average and lowest yields since 2013.

“It’s hard to determine whether this reflects position adjustments, expectations of higher BOJ rates, or both,” said Shoki Omori, chief desk strategist at Mizuho Securities in Tokyo. “There is a possibility overseas investors sold due to concerns over a slump in long-term bonds.”

Benchmark yields hit multi-decade highs on inflation and policy concerns

Since these operations, benchmark 10-year yields have surged to their highest since 2008, and those on super-long debt are at their highest in a generation. Yields will likely keep increasing due to worries about inflation, tighter monetary policy, and fiscal expansion.

The selloff comes as the BOJ, which owns more than half of Japan’s sovereign notes, moves forward with plans to trim its balance sheet and scale back bond purchases. Other buyers are failing to fill the gap. Mitsubishi UFJ Financial Group, Japan’s largest bank, reduced its domestic government bond holdings by 27% from March through June, while life insurers are also offloading notes that have incurred unrealized losses.

The strong selling pressure reflects increased expectations of a BOJ rate hike, said Tadashi Matsukawa, head of bond investments at PineBridge Investments Japan. Traders now forecast about a 70% probability of a move higher by December’s end, up from about 60% at the beginning of August, according to overnight index swaps.

Market awaits BOJ’s next move on bond purchases

As no long bond sales are intended for the week, the Bank of Japan’s 27 August buying of 5- 10 year debt is in focus. A hawkish result, potentially indicating a twilight of the extraordinary yield movements that have become common in previous operations, would send investors looking for signs of more selling pressure or changes in market sentiment. The BOJ’s latest move, cutting back its monthly JGB purchases to ¥4.5 trillion, the least since 2013, has shaken market stability.

The next purchase will offer crucial clues as to whether the BOJ can maintain stability in the bond market as it slowly phases out its huge bond buying. Market watchers are also gauging the potential impact on yields after banks and insurers have sold so aggressively that benchmark yields are trading at levels they have not seen in decades. 

Analysts say the operation would be a litmus test for the market’s appetite for JGBs when the prospect of a rising BOJ rate rises.