The yield on JGBs has continued to rise, and Japanese funds have initiated a domestic capital flow back to the country
Japan will speed up its pace of raising interest rates, which will gradually lift the yield on Japanese government bonds. The attractiveness of domestic assets has largely increased, driving domestic institutional funds to flow back from overseas.
Japanese bonds are no longer producing meager returns.
Last week, Japan's benchmark 10-year government bond yield broke above the 3% level for the first time in 29 years to reach a new high. The rise in yields was attributable to a combination of fundamental factors. Market concerns about Japan's persistent inflation and increasing fiscal pressure have intensified, along with the shift in the monetary policy of the Bank of Japan and the rising expectations for interest rate hikes. These factors jointly pushed up the yield of long-term government bonds.
The market consensus has formed that the Bank of Japan will complete an interest rate hike at the upcoming meeting, raising the policy rate to 1.25%. Unlike previous moderate adjustments, Fitch has given a more aggressive prediction, suggesting that the pace of interest rate hikes by the Bank of Japan from 2026 to 2027 will be faster than the general expectations in the market. The acceleration of monetary policy normalization will not only reshape Japan's domestic interest rate system but also trigger adjustments in the flow of funds.
The returns have picked up, and funds are flowing back to Japan.
For a long time in the past, Japan maintained a zero-interest rate and negative interest rate environment. Domestic bond yields were extremely low, even approaching zero. Large institutions in Japan, such as banks and pension funds, for the purpose of obtaining higher returns, have long invested a large amount of funds in overseas markets. European and American bonds, as well as overseas equity assets, were the main allocation targets for Japanese funds.
With Japan's inflation stabilizing and rising, and the tightening of monetary policy, the actual interest rate in the Japanese market has increased, and the investment value of domestic bonds has improved. In simple terms, investing in Japan does not require bearing the exchange rate fluctuations and geopolitical risks, and can obtain higher returns than before. The cost-effectiveness of funds flowing overseas has decreased.
The change in the direction of market funds has evolved from expectation to actual operation. Various Japanese institutions have begun to adjust their holding structures and gradually increase their investment in domestic yen government bonds in batches. The actions of large Japanese banks have been the most stable, currently gradually and slightly increasing their holdings of yen government bonds. The overall operation pace is cautious, in line with the stable operation style of banks.
The adjustment actions of life insurance companies are more flexible and decisive. These institutions hold a large amount of existing overseas bonds and low-interest domestic old bonds. Currently, they are actively selling low-yield old bonds, withdrawing funds, and re-investing in newly issued high-yield government bonds to optimize and upgrade their holding structures.
The market need not worry about the risk of large-scale selling of Japanese bonds.
As yields continue to rise, many investors have expressed concerns. Bond prices and yields move in opposite directions. Will the continuous rise in interest rates lead to a concentrated selling of Japanese bonds, causing significant market fluctuations? In response to this market concern, Fitch has provided a clear judgment. In the short term and medium term, there will not be a large-scale concentrated selling of Japanese government bonds. Although the yields of bonds of various maturities continue to rise, the demand for configuration by domestic institutions is steadily increasing, which can effectively absorb market supply and provide solid support for the bond market.
Multiple financial effects, influencing the yen and global liquidity.
This round of rising Japanese bond yields is triggering a series of chain financial reactions. At the exchange rate level, the acceleration of interest rate hikes combined with the return of funds will directly benefit the yen's trend, providing it with the impetus for appreciation and reversing the long-term weakness. At the global liquidity level, Japan is an important global source of funds. Over the past years, a large amount of Japanese funds have flooded overseas, providing sufficient liquidity for global bond and stock markets. Now that the funds are flowing back to the domestic market, the additional Japanese funds in overseas markets will decrease.