Japan’s sovereign debt market is flashing a warning to the central bank that dialing back its bond purchases needs to be done with great care.

The issue is in sharp relief this week, with investors shunning an auction of government debt and yields soaring, just as market participants sit down with Bank of Japan officials to share views on tapering. Comments from Prime Minister Shigeru Ishiba likening Japan’s financial position to that of Greece underscore the stakes for avoiding any missteps in fiscal and monetary policy. 

The drama in the nation’s $7.8 trillion government bond market, which has been building since US President Donald Trump unveiled his “Liberation Day” tariffs in April, is most acute for longer-maturity debt. That part of the market has been dependent on purchases from large Japanese institutions, such as life insurers, who are now waiting for uncertainty to clear.

“There’s almost a buyers’ strike in the back end of the curve,” James Malcolm, a London-based macro strategist at UBS, said in the wake of Tuesday’s sale of 20-year bonds, which drew the weakest demand in more than a decade. “And on top of that, the political situation is fragile and there’s more pressure for fiscal spending,” he said.

This has investors keenly focused on the BOJ’s hearings with market participants, which began Tuesday with commercial lenders and brokerages, and continues Wednesday with investors. There was no consensus among participants going into the meetings on the best course for policy, potentially keeping the current pace of tapering on track. 

But events in the market are likely to test this position in the lead-up to the BOJ board’s next policy decision on June 17. The Ministry of Finance will sell 40-year bonds on May 28, and upward pressure on US Treasury yields continues to ripple through to Japan. 

The BOJ’s reduction in its bond purchases means the market has to absorb an increasing amount of bonds, leading to lower prices. Net bond supply, which takes into account redemptions and the central bank’s debt purchases, climbed to the highest at least since 2010, according to Bloomberg analysis of central bank data.

In the market action on Tuesday in Tokyo, yields on 20-year notes jumped about 15 basis points to the highest since 2000, while those on 30- and 40-year bonds surged to record highs.

There is a lack of consensus on how much further yields may rise, as investors adjust to a market that is returning to a more natural — albeit volatile — state after a years of aggressive purchases by the BOJ to hold yields down to stimulate the economy. 

What Bloomberg Strategists Say…

Long-term JGBs are being treated with disdain, as though investors fear a credit ratings downgrade for Japan following the one seen for the US last week.

— Mark Cranfield, Markets Live strategist. Read more on MLIV.

“Storms may be brewing here that may spark off something more Japan-centric, in terms of the size of its debt and growing bond vigilantes in our market,” said Amir Anvarzadeh, Japan equity strategist at Asymmetric Advisors Pte. “All eyes are on whether Japan’s institutions are perhaps being asked by the MOF to raise their allocations in JGBs.”

The yield surge is another cause for concern for investors in Japanese stocks, which came under pressure Tuesday, said Kazuhiro Sasaki, head of research at Phillip Securities Japan.

“Prime Minister Ishiba has said issuing more bonds to fund the budget is unacceptable, but there doesn’t seem to be a consensus on economic measures,” he said. “The economic situation is quite uncertain.”

Others are relatively sanguine. For Hui Shi Yeo, a portfolio manager and researcher overseeing Japan equities at Singapore-based fintech firm iFast, “the recent rise in ultra-long yields may not necessarily be a red flag, but rather a reflection of economic normalization which could support corporate earnings.”

Still, higher yields point to increased borrowing costs for the government, Japanese companies and consumers, at a time of underlying shakiness in the economy, which flipped back into reverse in the first three months of the year. Uncertainty also remains over trade talks with the US, with Japan seeking the removal of all additional US tariffs on its goods.

The BOJ has said it intends to trim its purchases by ¥400 billion a quarter, putting it on course to reach monthly buying of around ¥2.9 trillion in the first three months of next year. 

A decade-long campaign of aggressive asset purchases left the BOJ holding more than half the nation’s outstanding government bonds.

With assistance from Masahiro Hidaka, Erica Yokoyama and Masaki Kondo.

This article was generated from an automated news agency feed without modifications to text.