Global fund managers grow bullish on Japanese government bonds

Global fund managers are warming to Japan’s bond market again as signs of recovering domestic demand and a more supportive policy backdrop add to the appeal of elevated yields.

T. Rowe Price Group, which scaled back exposure to Japanese government bonds earlier this year, now favors bonds with longer maturities. Allianz Global Investors is selectively adding intermediate- and long-dated bonds, while BNP Paribas Asset Management has built up its exposure to super-long debt.

The shift marks a reversal from earlier this year, when high yields alone weren’t enough to compensate investors for concerns that the Bank of Japan was raising rates too slowly, fiscal spending would swell debt supply and traditional domestic buyers remained on the sidelines. Expectations for further BOJ rate hikes and signs of returning demand from insurers are now giving fund managers more confidence to take advantage of those yields.

“We have become more constructive on JGB duration and have been selectively adding exposure, particularly in the intermediate to long end part of the curve,” said Mark Tay, chief investment officer for fixed income in Asia Pacific at AllianzGI, which manages €653 billion in assets. “Real yields are more attractive and we are seeing growing evidence of domestic demand returning and foreign interest, which should help support the market.”

The change in tone has coincided with a recovery in longer-dated debt. The 30-year JGB yield has fallen almost 40 basis points from a peak of 4.25% earlier this month, even as volatility persisted across global bond markets. The gap between two- and 30-year JGB yields has narrowed by about 70 basis points since July.

Japan will hold an auction of two-year government bonds on Thursday, where demand is expected to be solid.

Valuations became increasingly attractive as the 10-year yield climbed above 3% and the 30-year reached 4% earlier this year, levels unseen in decades, according to Shoki Omori, chief Japan fixed-income strategist at Deutsche Securities.

He estimates roughly two-thirds of those yields reflected term premium — the extra compensation investors demand for holding longer-maturity debt. Omori sees scope for that premium to shrink once the end of the BOJ’s tightening cycle comes into view, allowing the long end to outperform even as rate hikes continue.

Buyers return

Signs of improving demand are already emerging. Japanese life insurers have bought super-long government bonds on a net basis for the past four months, and some have signaled plans to maintain or increase domestic debt purchases. Overseas investors have also been net buyers of super-long JGBs for three straight months, reversing net selling in April and June, according to Japan Securities Dealers Association data.

Vincent Chung, a portfolio manager at T. Rowe Price, now favors the long end as the BOJ raises rates, expecting the yield curve to flatten. That marks a turnaround from earlier this year, when he bought JGBs in January after being underweight for the previous year, only to scale back a month later as fiscal concerns intensified.

Chung now sees supply and demand becoming more balanced toward year-end, helped by recent retail buying and the prospect of additional demand if proposed tax incentives are introduced. Potential changes to the Government Pension Investment Fund’s allocations could provide another source of support, though he said any decision would depend partly on global market performance.

BNP Paribas Asset Management has also been increasing exposure. James McAlevey, head of global aggregate and absolute return, said the firm has grown its long-end JGB position from a “very small size” early this year to a “moderate to medium size,” favoring 20- and 30-year bonds.

Fiscal test

Fiscal policy remains the biggest obstacle to a more sustained rally, with the fiscal 2027 debt-issuance plan set to test the nascent recovery in bond-market sentiment. Investors are closely watching how the government plans to fund a proposed sales-tax cut on food and higher defense spending.

T. Rowe Price’s Chung said his curve-flattening view would be at risk if the budget fails to identify clear funding sources. Deutsche Securities’ Omori warned that a larger supplementary budget or an issuance plan that fails to further reduce super-long supply could reverse the recent flattening in JGBs.

Brandywine Global Investment Management, which cut its JGB exposure and sold its 30-year holdings earlier this year, hasn’t bought back in. Portfolio manager Carol Lye said a shift in tone under Prime Minister Sanae Takaichi’s administration away from reflationary rhetoric has helped anchor yields, but investors are still waiting for a credible funding plan. With the 10-year yield back below 3%, she also sees scope for demand to slow.

The BOJ will provide another test at its policy decision Friday. Officials are widely expected to keep rates unchanged, leaving investors focused on Governor Kazuo Ueda’s guidance on the pace of tightening and how close rates may be to their eventual peak.

For BNP’s McAlevey, further conviction would require both a “relatively constrained fiscal response” from the government and continued BOJ tightening. The central bank doesn’t necessarily need to hike this week, he said, but a December move and continued “relatively hawkish” communication would be sufficient.