The Japanese long-term government bond market is experiencing a fierce round of selling off, and Wall Street is closely watching a potential bailout plan: the Japanese government may require state-owned institutions to massively purchase domestic bonds, with the funding source potentially being the sale of U.S. Treasury bonds in their hands.
This week, the auction of 20-year Japanese government bonds encountered a cold response, causing yields to soar and heavily hitting long-term bonds. Among them, the yield on 40-year bonds approached 3.7%, rising a full percentage point since April. For bonds with a duration close to 20 years, investors' losses within just a few weeks amounted to nearly 20%.
Ajay Rajadhyaksha, Chairman of Barclays Global Research, told the media in an interview that if this selling pressure continues, the Japanese government may have to use state-owned entities to support the bond market.
Rajadhyaksha proposed a much-discussed possible approach: key institutions like Japan Post and the Government Pension Investment Fund (GPIF) might be "quietly instructed" to increase purchases of government bonds. He said: "If necessary, the fastest way would be to tell Japan Post: 'You need to immediately buy $50 billion worth of long-term bonds.'"
But this solution is not without cost: to raise funds for buying Japanese bonds, these institutions are likely to sell overseas assets, with U.S. Treasury bonds — the foreign bonds held most by Japanese investors — being the first to be affected.
Behind-the-scenes Culprit of Japan's Bond Market Collapse
In an opinion piece for the Financial Times, Rajadhyaksha bluntly stated that Japan's bond market was "in trouble," pointing out several key factors leading to the collapse of the Japanese bond market:
Inflation remains persistently above 2%: Japan's inflation rate currently stands at 3.6%, consistently higher than 2% over the past three years, meaning the actual real interest rate for 30-year bonds with a yield of 3.15% is negative.
Traditional buyers stepping away: Japanese insurance companies have almost stopped purchasing ultra-long-term bonds to meet recently introduced economic solvency ratio requirements.
Fiscal concerns intensifying: The U.S. is urging Japan to raise defense spending to 3% of GDP (currently at 1.6%). The ruling coalition is considering additional budgeting, while opposition parties are pushing for reduced consumption tax rates.
The Bank of Japan begins quantitative tightening: The central bank still holds more than 50% of Japanese government bonds. However, with the end of deflation, the central bank has begun to reduce its balance sheet, allowing existing holdings of bonds to gradually be released into the market.
The turmoil in Japan's bond market has already started to impact global markets. Since Tuesday, the yield on 30-year U.S. Treasury bonds has risen by nearly 20 basis points, reaching its highest level since the crisis in 2008, exceeding 5%.
"Duration is substitutable across developed economies. If investors see sharp rises in yields on Japanese or British government bonds, they will rush to sell duration exposure in similar bond markets. What happens in Japan will not stay confined to Japan," Rajadhyaksha warned.
What Are Japan's Bailout Options?
In his Financial Times article, Rajadhyaksha analyzed several possible solutions, including the Bank of Japan potentially raising interest rates more quickly. However, the central bank's stance at its last meeting was surprisingly more dovish, with the next meeting scheduled for mid-June.
Rajadhyaksha believes that Japanese policymakers typically do not prefer taking action between meetings unless economic data shows significant weakness in the coming weeks, in which case rising yields are likely to continue.
In the absence of guidance from the market, Haruhiko Kuroda, Governor of the Bank of Japan, remained silent about the surge in government bond yields. It was reported that Kuroda said on Thursday after attending the G7 finance ministers and central bank governors meeting in Banff, Canada: "I don't want to comment on the specific details of short-term movements in bond yields, but I will certainly continue to monitor them closely."
Another option is that the Ministry of Finance could reduce the issuance of long-term bonds and increase the issuance of short-term bonds to alleviate pressure on long-term interest rates. However, the Ministry of Finance did so in April but failed, and it is reluctant to take unplanned actions.
Therefore, having the Japanese government "guide" state-owned institutions to buy bonds might be the most direct and effective way.
Rajadhyaksha admitted that it would be politically difficult for the Ministry of Finance to influence the investment decisions of quasi-governmental institutions in this way. But given that the Bank of Japan is unlikely to change its policy before its scheduled decision dates, this is a feasible option for officials hoping to control market trends.
However, even if institutions like Japan Post were to intervene in purchasing, Rajadhyaksha acknowledged this as only a temporary solution. He said: "If you want me to find fundamental reasons why the 30-year bond should remain at its current level rather than rise by 50 basis points based on current inflation conditions or Japan's fiscal situation, I cannot do so."
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