Japan To Issue Bonds With Shorter Maturities As BOJ Begins Tapering QE

With the constant implosion in the yen threatening to spark both runaway inflation and a currency crisis in Japan, especially after the latest toothless decision by the Bank of Japan, it finally appears that the BOJ is set to either hike rates, or trim its massive bond buying program, or some combination of both.

And since the BOJ is absolutely terrified of losing control of the Japanese bond market, of which it has been a majority holder for years, it was not surprising to learn that Japan’s Ministry of Finance is already weighing a plan to shift more of its bond issuance to shorter maturities, a major change as the central bank moves to cut purchases of government debt, one which will ensure less turmoil in the all important long-end, where duration is far higher, and where supply should be lower if the BOJ ends up purchasing less.

According to Bloomberg, Finance Ministry officials have prepared a draft proposal that calls for increasing the proportion of issued bonds with shorter maturities, with an expert panel expected to endorse the plan on Friday.

The move comes as the Bank of Japan’s decision to cut its bond purchases encourages the government to seek new sources of funding. The BOJ held about ¥590 trillion ($3.7 trillion) in JGBs as of the end of March, representing more than half of the total outstanding. It’s necessary to reduce the amount of yield risk supplied to the market by shortening durations, according to the proposal, which also cites floating-rate bonds as an option.

Similar to the so-called Yellen Twist, which saw the US Treasury flood the market with Bills in mid/late 2023 to avoid a surge in long-dated yields at a time when the US is issuing record amounts of debt, shortening maturities on bond sales would represent a stark shift from the recent trend in which the Japanese ministry has tended to extend the maturities on bonds it sells as the nation’s policy interest rates have stayed around zero for decades and the BOJ used its yield curve control mechanism to cap long-term yields.

The BOJ has been terrified of implementing major changes to the country’s petrified bond market, where the BOJ has long been the first and last buyer of any resort: while the central bank ended YCC in March, when it raised interest rates for the first time in 17 years, it did so in the most dovish way imaginable, effectively guiding the market to expect barely any further tightening for the foreseeable future. The yen tumbled. Then, last Friday, the BOJ said it will release details of its plans to reduce bond buying at the July 31 conclusion of its next policy meeting; and since the market was expecting the central bank to actually do something this time instead of just more talk, the yen tumbled even more.

But it now appears that some definitive move is coming, and ahead of the July disclosure, the bank is meeting with market participants to hear their views.

The finance ministry’s working draft, prepared ahead of a ministry meeting with market participants and experts on June 21, notes that shortening maturities would increase refinancing and interest risks for the government, so it recommends expanding the pool of government bond holders as much as possible.

The ministry sent out a questionnaire to market participants, including potential bond buyers such as insurance companies, banks and foreign investors, at the last panel meeting in May. The ministry plans to release the results of that survey in addition to its proposal for future issuance on Friday, the person said.

According to Bloomberg, the banking sector could become a major new customer to replace the BOJ, a respondent noted in the MOF’s survey. But we strongly doubt it in light of the latest news that Japan’s “farmer” bank, the $700 billion Norinchukin is getting stopped out of its foreign bond holdings which it must sell to plug huge “unrealized” losses. And if Nochu has to sell foreign bonds, how can one possibly expect it to buy Japanese bonds just when yields are expected to keep rising for the foreseeable future as the BOJ embarks on its first tightening campaign in decades.

The bottom line is that while the BOJ’s plan suggests that the key to JGB management policy is “to create an environment in which the banking sector can hold JGBs with confidence”, the realty is that since in Japan monetary policy has been a total disaster for years, the one guaranteed outcome is that a bond crisis is imminent.