JGB’s Join the Higher Bond Yield March with a Bout of Bear Steepening Concentrated at the Long End
The risk/reward prospects of owning longer-dated government bonds from current historically suppressed levels are as attractive as a bucket of dry sand after a sweaty jog.
As Bloomberg notes, Japan’s bond market is enduring pressure due to recent BOJ policy adjustments.
Japan is deepening a global bond selloff after a reduction in central bank purchases fueled the perception that it’s persisting with stealth tapering. Twenty-year yields jumped to the highest level since April 2017.
The Bank of Japan trimmed its buying of bonds due in more than 25 years by 10 billion yen ($88.9 million), to 50 billion yen at its regular operation on Friday — the first reduction in the segment since July. That was enough to send local yields climbing close to the highest levels since the central bank introduced its negative interest-rate policy in January 2016.
For at least the past decade, the strongest justification for owning developed market sovereign bonds carrying nonsensical negative real yields, such as Japanese JGB’s, has been front-running the telegraphed combined purchases of global central banks in order to receive capital appreciation on the manipulated market value of bond prices rather than the actual coupon payments they were designed to provide.
The action of central banks creating new money from thin air with which to purchase financial assets such as government bonds, likely contributed to the very inflation which caused the bonds to yield substantially less than the pace of price increases throughout the rest of the economy.
At least pension and insurance institutions knew when they bought government bonds that their friendly reserve bank was waiting in the wings to buy them at an even higher price with printed money. Basically, a classic “greater fool” trade, the “fool” being the central bank. Except, the central bank was allowed to take the risk with money created for nothing, so the real joke was on savers and citizens without access to the gravy train of zero interest rate borrowing on the other side of the coin. But I digress.
This dynamic is beginning to change, even if ever so slowly, as major central banks back off the ledge of the skyscraper rooftop with less extreme monetary policy.
It is numbingly easy to find one deflationary bear after another in the financial pundit-sphere clinging on to their 1,327th incorrect prediction of the past 5 years. The brunt of these outdated pre-2008 crisis mindsets suggests an imminent safe haven rotation of capital into “safe” government bonds as risk assets all crash simultaneously, and Larry Summers is back on TV every day like an impassioned Armageddon preacher shouting from a stormy mountaintop about prospects of a negative 0.1% CPI reading leading to Great Depression bread lines.
As noted for several months, we continue to expect higher government bond yields in developed markets–particularly, the US, Europe, and Japan. The big 3 central banks will continue to pare back on asset purchases and there remain even fewer reasons for any rational investor to want to own deeply negative (real) yielding bonds as unsustainable debts pile up, populist leaders gain favor in western world politics, and inflation rises.