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Foreign investors are piling into long-dated Japanese government bonds at the fastest pace in more than two decades this year, attracted by a sharp rise in yields in a market that has for years offered few profits for traders.
Data from the Japan Securities Dealers Association shows that foreign investors bought a net ¥11.3tn ($71.8bn) of JGBs with a maturity of more than 10 years this year to the end of October — higher than any comparable period since records began in 2004.
Yields on 30-year JGBs have soared from 1.6 per cent at the start of last year to touch a record high of 3.41 per cent on Thursday, as inflation and interest rates have risen, while 20-year bond yields have jumped from 1.39 per cent to 2.88 per cent — a level last seen in 1999. Yields move inversely to prices.
For foreign investors, the relative attractions of long-dated JGBs are even greater thanks to the effects of currency hedging, which delivers an additional return from the difference in short-term borrowing costs between the yen and other major currencies.
Yields “compare favourably to debt of a similar maturity from all other developed nation economies”, said Gareth Hill, a fund manager at Royal London Asset Management, who said a sterling-hedged investor could get yields of about 6.5 to 7 per cent on 30-year debt. RLAM added to its bet on long-dated JGBs over the summer.
Pimco said earlier this year it was buying long-term JGBs to take advantage of a market “dislocation”.
Foreign investors’ growing participation has come amid a brutal sell-off in the market, as lower demand from traditional domestic buyers — such as the Bank of Japan, life insurers and regional banks — left it oversupplied with bonds.
Life insurers had over the past few years stepped up demand for long-dated JGBs in anticipation of a regulatory change scheduled for April 2025 that required them to more closely match the duration of their assets and liabilities.
But after the regulatory update entered force, “lifers that are compliant with the rules no longer need to build up long-dated bonds,” said Masahiko Loo, senior fixed-income strategist at State Street Investment Management.
“This technical factor has played the biggest role in dampening demand for long-dated JGBs,” he added.
The revamped NISA [Nippon Individual Savings Account] scheme that the Japanese government introduced in early 2024, which encourages retail investors to put their money in the stock market, has also hit life insurers’ appetite for long-dated JGBs.
NISA had prompted Japanese households to shift their savings out of life insurance policies, historically a major vehicle of household investment, said Matthew Hornbach, global head of macro strategy at Morgan Stanley. Meanwhile, the shrinking average life expectancy of the large and wealthy baby boomer generation meant less demand for longer-dated debt.
“Life insurers now have fewer liabilities to hold long-term assets against, which means their demand for long-dated bonds is now structurally lower,” he added.
The BoJ is also stepping back from the market. Having reduced the pace of its purchases of bonds up to 10 years from August 2024, in March the central bank announced it would also taper purchases of bonds with a maturity between 10 and 25 years.
These demand-sapping forces were reinforced by a bout of acute selling pressure as US President Donald Trump’s “liberation day” tariff announcements roiled bond markets. In Japan, investors were spooked by July’s Upper House parliamentary elections, which were seen at the time as a potential catalyst for further fiscal loosening.
The resulting sell-off generated substantial paper losses for other domestic players in the long-dated JGB market, such as regional banks. “Other risk-averse domestic investors were put off from making purchases, removing another source of domestic demand,” said Masamichi Adachi, chief Japan economist at UBS.
Following the sell-off, the BoJ announced in June that, starting in April next year, it would slow the taper of its bond purchase programme. The MoF has announced two reductions to the issuance of very long-dated debt this year.
While overseas investors’ footprint in Japanese government bond markets is still modest, analysts say one of the consequences of their rising participation is that future governments’ fiscal policy choices are likely to face more scrutiny than previously.
“International investors are much more easily unnerved by deficit spending increases or general fiscal irresponsibility than domestic bond buyers, who have a home bias,” said Adachi.
“More international participation will make the market function better, and the price signal will actually work. But the government will become more constrained in what it can do and say,” he said.
A better functioning Japanese bond market that was easier for foreigners to participate in could also draw in global investors looking to exit their positions in other countries’ debt markets, said Ales Koutny, head of international rates at Vanguard.
“With Dutch pension reform coming up and an uncertain fiscal picture in the US, other major bond markets have also seen instability at the long end,” he added.
“The rise of Japan as a plausible destination for international bond investors could be the next trigger of a big stress episode in global long-dated yields.”
Additional reporting by Ian Smith