"Haven of safety" no longer calm? Foreign capital stirring up storm in Japanese government bonds

Recent political turmoil and concerns about the central bank raising interest rates have heightened investors' uncertainty. A large amount of foreign capital has poured into Japan's ultra-long-term government bonds, leading to more intense fluctuations in what was originally a stable yield curve. As market expectations adjust regarding changes in government spending under the next prime minister and the timing of the Bank of Japan's interest rate hikes, the yield curve of Japanese government bonds (an indicator reflecting the level of bond yields for various maturities) has shown significant changes recently. This month, fiscal hawk candidate Sanae Takaichi was elected leader of Japan's ruling party and is expected to become the prime minister. This news pushed the 30-year Japanese government bond yield to historic highs. However, due to market doubts about Takaichi's ability to secure enough support in parliament to lock in the prime minister position, the 30-year bond yield fell back, leading to short-term rate fluctuations. Tomoaki Shishido, senior interest rate strategist at Nomura Securities, stated that this tug-of-war fluctuation in yields is mainly influenced by overseas investors holding long-term government bonds, as these investors are "eager to bet based on political signals." Data from the Japan Securities Dealers Association shows that as of August, foreign investors have been net buyers of Japan's ultra-long-term government bonds for eight consecutive months. In April of this year, their monthly purchases of such bonds reached a record 2.3 trillion yen (approximately $15.56 billion), far exceeding the buying volume of traditional major buyers - Japanese domestic life insurance companies. "We still maintain a underweight position in overall Japanese government bonds, as we expect actions from the Bank of Japan may happen faster than the market expects," said Vincent Chung, fixed income investment portfolio manager at Fidelity Group based in Hong Kong. "Considering the attractiveness of the 30-year government bond, we have started to gradually adjust our underweight position... I think that, given the steepening yield curve, the current long end (government bonds) still has appeal." The Bank of Japan ended its negative interest rate policy last year and continues to adhere to a gradual path of interest rate hikes, contrasting sharply with the loose policies of most other major central banks. This tightening measure has reinvigorated the relative value trading in the Japanese market, whereby investors profit by simultaneously going long on one end of the yield curve and short on the other end. "When the Bank of Japan maintains negative interest rate policy, there is limited volatility in short-term bonds," said Toru Suehiro, chief economist at Daiwa Securities. "But now that both ends of the curve are volatile, investors find it easier to bet on the shape of the curve." On October 4, Sanae Takaichi won the final vote and was elected leader of the ruling party, the Liberal Democratic Party, with the potential to become Japan's first female prime minister. However, last week, the long-standing ruling coalition partner, Komeito, abruptly withdrew from the ruling coalition, changing the outlook for its rule. Additionally, the Bank of Japan will hold a monetary policy meeting this month. The current market expectation for a rate hike at this meeting is only 20%, compared to nearly 40% at the beginning of the month. Kentaro Hatono, head of the Global Fixed Income Department at Asset Management One, stated that against the backdrop of investors making two-way bets on the above events, the once stable Japanese government bond market is facing more volatility risks. "Investors are finding it increasingly difficult to see government bonds as safe-haven assets," Hatono admitted.