Japan’s bond rebound: a flash in the pan? Bank of Japan’s holdings fall below the 50% threshold, selling pressure far from over

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Japanese government bonds extended their rebound on Thursday, but analysts warn this may only be a temporary respite.

Japan’s super-long government bonds rebounded for the second consecutive day on Thursday, with the 30-year bond yield once dropping 10 basis points to 3.62% and the 40-year yield falling 7.5 basis points to 3.980%. This followed a dramatic sell-off on Tuesday, when yields for some maturities surged more than 25 basis points in one day.

However, according to a Bloomberg report on Thursday, the Bank of Japan’s share of government bonds has fallen below the critical 50% level to an eight-year low. As the central bank continues to reduce the scale of its bond purchases, the market is losing its most important support and the structural pressure from selling has far from abated.

Finance Minister Katayama Satsuki has called for calm in the market, and some fund managers see the recent jump in yields as a buying opportunity on dips. However, the market is worried that the government and central bank may need to take further action to curb surging yields.

Investors are closely watching the Bank of Japan’s policy decision and statements from Governor Kazuo Ueda on Friday, as well as next week’s auction of 40-year government bonds.

BOJ Holdings Fall Below Key Level

The Bank of Japan’s share of government bonds has fallen to its lowest level since 2018. According to Bloomberg macro strategist Simon White, the BOJ’s share of outstanding government bonds has dropped below 50%, the first time in eight years.

The BOJ has been steadily reducing its bond purchases. In mid-2024, the central bank was buying 5.7 trillion yen in bonds per month; it has since dropped to 2.9 trillion yen, and is projected to fall further to 2.1 trillion yen in early next year.

While this is a positive signal for long-term financial stability, in the short term the market is losing its most critical support. As the BOJ gradually exits, the bond market will continue to face risks of disorderly selling.

Multiple Sources of Selling Pressure

Besides the BOJ's reduction, foreign investors are also cutting their holdings of Japanese debt. Data show that the proportion of Japanese bonds held by foreign investors relative to total outstanding continues to decline. Although overseas buyers have never shown strong interest in Japanese bonds and prefer Japanese equities, the shrinking share still adds extra resistance.

In the short term, life insurance companies may sell off recently purchased bonds. Insurance companies are typically net sellers, but more attractive yields had previously drawn them in. In December last year, their purchases of long-term government bonds hit a record high.

But the price of the 40-year government bond has dropped by as much as 8% compared to the peak in mid-December. Persistent price pressure may force life insurers to cut losses and exit.

Market Volatility Expected to Persist

Kazuya Fujiwara, fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities, said that the sharp fall in super-long yields reflected a rebound after excessive bond selling earlier this week. "Bond market volatility remains high, so yields often swing significantly up and down."

Yuichiro Tamaki, leader of the Democratic Party for the People, suggested on Wednesday the possibility of buybacks of government debt and reducing issuance of 40-year government bonds as further actions.

Naoya Hasegawa, chief bond strategist at Okasan Securities, said the discussion about consumption tax reduction has now been digested. But he warned, given uncertainties in election activities and parliamentary deliberations, "persistent buying demand is still hard to materialize."

Analysts believe the current relative calm in Japanese government bond yields may be just a temporary phenomenon. The Bank of Japan and the government face a daunting task: dealing with a market that has lost decades-long, artificially maintained support.

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