The shorter the better: BoJ rate rise changes tone of Japan’s bond market

Among all the world’s major central banks, the Bank of Japan takes this year’s prize for keeping market participants on their toes.

Take its July 31 announcement: after a policy meeting, the BoJ raised its policy rate to 0.25%, taking many by surprise as there was little evidence that inflation was rising. Simultaneously, it confirmed plans to cut its monthly purchases of ¥6tr ($40.6bn) of Japanese government bonds (JGBs) by ¥0.4tr every quarter to ¥3tr by the first quarter of 2026.

The July rate increase was a landmark moment, as it signalled a major shift in Japan’s ultra-loose monetary policy.

Critically, it came after years of large stimulus programmes and an eight-year period of negative interest rates, which the BoJ ended in March when it raised the rate by 10bp to a 0%-0.1% range.

But instability immediately followed July’s increase. The hike, combined with hawkish comments from BoJ governor Kazuo Ueda, triggered an unprecedented spike in the yen from near a multi-decade low, disrupted yen carry trades, and caused a global stock market rout in early August.

The increase also marked a turning point for Japan’s bond markets.

The country’s ultra-low interest rates meant borrowing was cheap for Japanese companies and global borrowers looking to sell Samurai bonds at minimal cost. But by normalising Japan’s rate regime, the BoJ effectively ended this era — even if yen rates remained much lower than those in dollars and euros.

“There is a very clear message to the market, to issuers and to investors, that rates may go higher in the future,” says Hiroshi Oikawa, head of Japan DCM syndicate at Bank of America, Tokyo. “What that means is that investors are becoming cautious, and from an investment grade bonds point of view, there is demand towards the shorter end to the five year part of the curve. This is purely because of the risk that comes with longer duration bonds.”

Debt bankers in Tokyo and the rest of Asia say yen bonds sold since July’s rate rise reflect investors’ preference for shorter tenors and their reluctance to load up on longer tenor bonds.

Take the ¥162bn dual-tranche Samurai bond sold by the ANZ in mid-September. The bank opted for three and five year tranches, taking ¥110.4bn from the three year portion — more than double the size of the ¥51.6bn five year tranche.

“This deal shows that the shorter end of the curve is more constructive than the longer end,” says a Singapore-based DCM banker familiar with the situation. “For longer tenors, borrowers will need to pay a higher spread so investors can feel comfortable taking that risk.”

When West Nippon Expressway Co turned to investors in late August, it opted for a four tranche outing, taking ¥20bn from a 0.489% two year, ¥90bn from a 0.67% five year, ¥19bn from a 0.8% seven year, and ¥12.7bn from a 1.007% decade note, shows Dealogic.

Other issuers, such as Mizuho Leasing Co and NTT TC Leasing Co, included three year portions in their August deals, while firms like Nagoya Expressway Public Corp and Nexco East had two year tenors in their September transactions, according to Dealogic data.

BofA’s Oikawa says issuers have to pay 10bp-20bp more in spreads for longer-dated bonds since July.

“It varies from issuer to issuer, of course, but the shorter curve is relatively more stable compared to longer tenors of seven or 10 years,” he adds.

As a result, Oikawa says he expects spreads in the shorter end of the curve, such as three or five years, to be stable, while bonds of 10 years or longer could be subject to volatility and further widening as investors factor in risk premiums for those maturities.

Yields on the benchmark 30-year JGBs, for instance, have risen about 40bp to more than 2% following the BoJ’s rate raises.

The yen bond market offers plenty of buying opportunities for international and domestic investors.

Global issuers of yen debt will also have a strong following among international portfolio managers. Samurai bond issuers typically pay small premiums over their local currency bonds, appealing to asset managers who prefer to buy Samurai and then swap to their local currencies to pick up extra yield.

Domestic investors, on the other hand, have long looked outside Japan for higher yields, but market watchers say many will start reining in their external investments and returning to yen over the next few quarters.

Many large Japanese investors have been burnt by their global investments. For instance, in June Norinchukin Bank said it would sell ¥10tr or more of its US and European government bonds, as higher global interest rates were hurting its financials. The bank’s investments had largely been funded by high-cost short-term borrowings that led to losses as the investment income was less than the cost of the funding. As of March 2024, Norinchukin had ¥24tr-equivalent of foreign bonds on its books.

Other Japanese investors are in a similar boat. As yields on long-term JGBs rise, market watchers say there will come a point where some of Japan’s largest asset managers, such as insurance firms, will start to bolster their holdings of local debt.

Japan’s local corporate bond market can also be appealing. In the year to October 2, Japanese issuers raised around $17.4bn-equivalent via 554 yen-denominated bonds, according to Dealogic data, just a little less than the $18.2bn via 580 trades during the same period in 2023. But this year’s tally is still higher than year to date volumes for 2021 and 2022.

Bankers say the pipeline for Japan is strong, across both domestic yen issuance and global deal flow.

“Japan overall is a theme people are focusing on globally,” says Oikawa. “Japan is the only central bank in the world hiking rates now when every other central bank is cutting rates, which means that a lot of issuers, investors and market participants are keen to know what is happening in Japan. What is the economic cycle in Japan? How are rate movements likely to be and what are the new opportunities in Japan? It helps that Japanese corporates are very strong and have healthy finances.”