Hedged return rate approaches 6.5%! BNP Paribas Asset Management increases allocation in ultra-long Japanese bonds, as foreign capital bets on curve steepening and domestic demand recovery

BNP Paribas Asset Management has been increasing its positions in ultra-long Japanese government bonds, attracted by the steep yield curve and signs that domestic demand in Japan is returning to the market.

James McAlevey, Global Head of Aggregate and Absolute Return at the firm, stated that the company has raised its ultra-long JGB holdings from "very small" at the start of the year to a "moderate size", focusing on 20-year and 30-year government bonds.

McAlevey said at a briefing in Tokyo: "We prefer the long end of the market because the curve is very steep." He noted that this segment has "significantly outperformed other global long-end products" recently, providing a source of diversification.

In some flexible strategies, the firm is shorting 2-year and 5-year JGBs while going long on 20-year and 30-year bonds, essentially betting on the yield curve flattening.

This bullish stance comes as yields on ultra-long JGBs have climbed to multi-decade highs this year on concerns about inflation, fiscal spending, and the Bank of Japan’s policy path. Surging yields are increasingly attracting buyers; the most recent 20-year bond auction saw record demand.

According to McAlevey, after converting to US dollar-hedged terms, yields on ultra-long JGBs are around 6% to 6.5%, making them especially attractive to overseas buyers.

By contrast, Japanese domestic investors have previously been "relatively absent" from the long end of the market because insurance companies have been busy addressing impairment issues related to low-coupon bonds. But the boom in recent auctions indicates that domestic demand is "returning to the long end of the JGB curve."

According to data from the Japan Securities Dealers Association, Japanese insurance companies have been net buyers of ultra-long JGBs for the past four months. Several life insurers have also signaled plans to maintain or increase their purchases of domestic bonds in the second half of the current fiscal year.

McAlevey said that the government's "relatively restrained fiscal response" will strengthen his confidence to further add to his Japanese bond positions. At the same time, he is watching whether the Bank of Japan can maintain the pace of roughly one rate hike per quarter, as he expects.

He noted that the central bank does not necessarily need to raise rates at its next meeting; a December hike with continued relatively hawkish communications would be sufficient.

McAlevey said that a stronger yen will further support the long end of the market by helping to contain overall inflation and easing pressure on the Bank of Japan. Earlier this year, yen weakness exacerbated dual pressures on the bond market and the central bank, but he believes this trend is beginning to reverse.