Japan's Bond Market Brace for Decade-High Supply as BOJ Tapers Purchases

Get ready for a flood of Japanese government bonds. Investors are facing a perfect storm of rising interest rates and a massive increase in bond supply as the Bank of Japan (BOJ) scales back its bond purchases, reports Bloomberg.

The Ministry of Finance typically releases its debt issuance plans in late December, outlining the amount of bonds to be sold in the upcoming fiscal year starting April 1. Bloomberg analysis suggests that, based on current trends, the bond supply could surge by 64% to ¥56 trillion ($390 billion) in fiscal 2025, considering both redemptions and BOJ purchases.

This dramatic increase stems directly from the BOJ's ongoing efforts to normalize its monetary policy. The central bank plans to nearly halve its bond purchases between July 2024 and March 2026, leading to a ¥37.6 trillion decrease in its bond holdings next fiscal year. This coincides with the BOJ's gradual interest rate hikes aimed at curbing inflation, while Prime Minister Fumio Kishida simultaneously pursues expansionary fiscal policies to address economic challenges and bolster his political standing.

"The current pace of the BOJ's purchase cut is having a severe impact over the market's supply-demand balance," warns Eiji Dohke, chief bond strategist at SBI Securities Co., to Bloomberg. Dohke cautions that the BOJ might need to slow its bond purchase reduction if Kishida's administration implements popular spending programs that necessitate increased government borrowing.

This confluence of factors is creating a perfect storm for Japanese government bonds (JGBs). The BOJ, which held over half of outstanding government bonds as of November, is gradually reducing its holdings. While Governor Kazuo Ueda previously indicated that the BOJ's bond holdings would decrease by 7% to 8% over roughly two years, he acknowledges that these levels remain higher than ideal in the long term.

While some market participants downplay the severity of the increased bond supply, others are sounding the alarm.

"With the central bank cutting purchases, yields risk rising as the supply-demand balance in the bond market worsens," says Makoto Yamashita, chief economist at the Shinkumi Federation Bank, to Bloomberg. Higher yields, in turn, could discourage bond purchases, further exacerbating upward pressure on yields.

JGBs have already been struggling, declining by over 2% since the start of the current fiscal year, putting them on track for an unprecedented sixth consecutive year of losses. Financial institutions and investors surveyed by the BOJ anticipate the benchmark 10-year yield to climb to 1.32% by March 2026, up from approximately 1% currently.