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Smaller pond, bigger whale may tame yields

TOKYO -- Japan's government debt market looks to tighten next fiscal year, with the Bank of Japan stepping up bond buying even as Tokyo cuts back on total issues.

     The yield on newly issued 10-year Japanese government bonds hit 0.34% at one point Monday, the highest level since Oct. 1. Improved U.S. employment data released Friday heightened expectations that the Federal Reserve will hike interest rates in December, boosting yields both in the U.S. and Japan.

     Still, the yield gains for JGBs were fairly modest compared to those for other bonds abroad. Many investors remain convinced that yields will fall again.

Cutting back

The Ministry of Finance typically draws up its bond issuance plan for the coming fiscal year in late December. Markets see planned fiscal 2016 issues as totaling between 163 trillion yen ($1.31 trillion) and 164 trillion yen, down from the 170 trillion yen initial figure for fiscal 2015. The value of bonds issued to the market, bid on by institutional investors and others, is forecast to drop by 3 trillion yen to 4 trillion yen, landing between 148 trillion yen and 149 trillion yen. The market will grow that much tighter, with yields poised to sink as prices swell.

     If Tokyo decides to cut market issues, the breakdown of those cuts by maturity will be set with regard to feedback from primary dealers and other institutional investors. Many see the government shifting the balance toward 10-year and other long-term bonds. "Issues of two- and five-year bonds will very likely be trimmed," said Masahiro Nishikawa of Nomura Securities.

Ballooning bank presence

The Bank of Japan is also expected to step up bond purchases next fiscal year, making the market even tighter. The central bank has been buying government debt as part of its quantitative easing program at the pace of 80 trillion yen per year. But some 14% of the bank's bond holdings, around 39 trillion yen worth, will come up for redemption in the next year. Assuming that those proceeds are reinvested, the bank stands to snap up 119 trillion yen in bonds, up from around 110 trillion yen this fiscal year. At that rate, the bank will buy up more than 90% of the long-term bonds issued in fiscal 2016.

     "Even if the Bank of Japan does not step up easing, tightness in the bond market will likely send long-term yields dropping toward the all-time low of 0.195% from this past January," Kazuhiko Sano of Tokai Tokyo Securities said.

     Some others believe that a decision by the Fed to hike interest rates could put upward pressure on Japanese bond yields, considering the correlation between rates in Japan, the U.S. and Europe. Yet it is uncertain whether U.S. interest rates would continue to rise for long amid concerns of slowing emerging economies and a strong dollar dragging on American corporate earnings. Observers seem to be giving more weight to inevitable developments at home than to hazy prospects abroad.

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