A banker who has spent more than three decades watching Japanese government bonds is bracing for the possibility that long-term yields hit levels unseen in a generation as the central bank moves away from negative rates.
(Bloomberg) — A banker who has spent more than three decades watching Japanese government bonds is bracing for the possibility that long-term yields hit levels unseen in a generation as the central bank moves away from negative rates.
Masamichi Koike, the head of global markets business at Japan’s second-largest lender, Sumitomo Mitsui Financial Group Inc., warns that 10-year yields could triple to 2% should inflation stay above the Bank of Japan’s target, prompting policymakers to eventually lift their short-term benchmark to 1%. The last time overnight rates were that high was in 1995, after the bubble economy burst.
The coming surge in borrowing costs may gain momentum after April if the BOJ judges that wages will keep their upward trend following negotiations between companies and labor unions in spring, Koike said. He didn’t provide a timeframe for when the short-term rate may go to 1% and 10-year yields to 2%, which could take several years.
The executive reminisces about the days when profits could be made by purchasing high-yielding bonds and selling them when central banks cut rates.
“The past 30 years were the era of low inflation, low yields and low volatility — those days are over,” said Koike, 59, who began his banking career in 1987. “The investment strategies during the days of low inflation do not work any more.”
Koike’s instincts on BOJ policy helped him navigate volatility in the wake of its surprise tweak to the yield-curve control in July. He had assigned a more than 50% probability to the move, building positions that delivered a profit for SMFG, which manages 33 trillion ($224 billion) in securities, while many other investors were caught on the wrong foot.
Uncertainty has damped demand at Japan’s debt auctions, adding to the challenges of policymakers after investors baulked at the yields on offer in sales last month. New 30-year debt drew a lower-than-estimated cut-off price Thursday amid expectations yields will continue to climb.
Traders are trying to judge the level of yields needed for Japanese buyers to load up at home and offload foreign holdings, potentially setting off a repatriation that could exacerbate this year’s global bond selloff.
While it’s inevitable that the BOJ will be raising rates, the process is likely to be gradual so that it doesn’t kill the virtuous cycle of price increases and income growth, Koike said. Overall, the BOJ’s latest move was “excellent” in that it helped restore the market’s functionality, he said.
The changing financial climate will require SMFG to improve its use of digital tools for market operations, Koike said. Of the approximately 500 markets staff working at its core banking unit, excluding those hired at its overseas offices, about 30 have the necessary skills and expertise. He wants to eventually increase that number to 100.
In the meantime, Koike said he will continue to start his day at 4:50 a.m. in Tokyo to get a headstart on the market. Getting the timing right for bonds is a big challenge, he said, noting that “we need to watch out for buying too much, too fast.”
–With assistance from Sumio Ito.
(Adds 30-year auction in seventh paragraph.)
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