Japan: Election uncertainties but little impact on JGBs – HSBC

According to Dayeon Hong, Rates Strategist at HSBC, while uncertainties still persist with a large number of undecided votes for the upcoming election as indicated by the latest polls, so long as there is a comfortable lead for Abe JGB yields are unlikely to budge prior to the election.

Key Quotes

“In a scenario of an LDP win, market participants are likely to expect the BoJ to maintain its easy monetary policy stance particularly in regards to its commitment to yield curve control (YCC) policy. While the polls show a win by the Party of Hope is unlikely, any unexpected result could heighten volatility in the bond market. JGB yields could initially rise sharply. However, the central bank is highly likely to initiate a fixed rate operation in order to cap 10yr JGB yields at 0.1% under the YCC policy framework as previously done on 7 July 2017 when the 10yr JGB yield nudged higher above 0.1%.” 

“The BoJ’s monthly JGB purchases have indeed declined lately. In September, only JPY7.9trn was bought compared with the monthly average of JPY9.9trn in 2016. Moreover, the BoJ’s net monthly purchase amount fell into negative territory for the first time in September i.e. the redemption amount from the stock of the central bank’s JGB holdings was larger than the total amount of JGBs purchased by the BoJ. Despite the ongoing reduction in the central bank’s bond purchase amount, the 10yr JGB yield has been well-anchored around 0%. This suggests that market participants’ focus has already been shifted towards the YCC policy rather than the quantity of BoJ’s bond purchases.” 

“In the absence of an immediate change in monetary policy stance by the BoJ, JGB volatility would likely remain low in the near term allowing investors to reach for duration. The latest auctions have already revealed investors’ appetite for super-long JGBs. For example, the 30year JGB auction on 11 October recorded the highest bid-to-cover ratio since March 2016. Note that in March 2016, the 30-year JGB auction incurred a c25bp intra-day drop in yield as a result of the negative interest rate policy introduced on 29 January 2016. This was also the strongest bid seen since the introduction of the yield curve policy in September 2016 and reflects investor confidence that the BoJ will continue to cap bond yields.” 

“Abe’s pledge for a fiscal boost has little bearing on JGBs Abe’s plan to spend an additional JPY2trn should not have a material impact on JGBs given that it accounts for less than 0.2% of the total outstanding JGBs (including T-bills) which stands at JPY1036trn currently. With ongoing efforts for fiscal consolidation, including a possible consumption tax hike in October 2019, JGB supply is unlikely to rise significantly, in our view. Even in the case of a larger fiscal boost in the medium term, the supply of bonds available for purchase by investors is expected to reduce as the central bank continues to ramp up its ownership of JGBs, albeit at a marginally slower pace.”