Bond Watch: Bank of Japan triggers a bond sell-off

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

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Japanese bond yields finally rise

The Japanese central bank loosened its yield curve control policy, where it was buying an unlimited amount of its 10-year bonds to keep the interest rate near zero, with a fluctuation of 0.25 percentage points allowed.

The band has now doubled to 0.5 points, which will allow yields to rise higher than before. Yields on the Japanese 10-year bond have nearly doubled since the news, from 0.28% to 0.52%.

Deutsche Bank says the Bank of Japan’s decision has several broader implications.

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Jim Reid, head of global fundamental credit strategy at the firm, said: “It could mark the start of a move away from ultra-loose monetary policy in Japan, then that could see Japanese investors shed their foreign bond-holdings in favour of domestic ones that now attract a higher yield. 

“We’ve also seen a big reduction in the quantity of global debt with a negative yield following the Bank of Japan’s move, with Bloomberg’s index down to $686 billion, which is down from $14 trillion only a year ago, and a peak above $18 trillion in late-2020.”

If Japanese investors move money out of global bonds and into domestic ones, then this would be bad news for developed world sovereign bond prices.

A bad December for bonds

The news out of Japan contributed to a bad month for gilts, as investors anticipated Japanese investors selling UK bonds for domestic ones.

The yield on the 10-year UK gilt rose from about 3% at the start of December to nearly 3.6%, with bonds across the yield curve, but particularly longer-dated bonds, also seeing steep price changes. The typical gilt fund is down 4% in December.

Corporate bond funds also suffered, with the average sterling corporate bond fund losing close to 2% in value.

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The Bank of England raised interest rates 0.5 percentage points in December to 3.5%, with six out of eight members of the committee supporting the increase.  

The Bank of England said: “The labour market remained tight and there had been evidence of inflationary pressures in domestic prices and wages that could indicate greater persistence and thus justified a further forceful monetary policy response.”

If inflation becomes more embedded, then this could lead to higher interest rates for longer, which would be bad news for bond prices.