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Japan stock market Copyright Koichi Kamoshida, Getty Images

Cracks Are Appearing in Bond Market That Led Record Global Rally

(Bloomberg) -- One of the pillars of 2016’s record-setting global bond rally is starting to buckle.

Japan’s sovereign debt is suffering its worst rout in 13 years, handing investors bigger losses over the past two months than any other government bonds amid speculation the Bank of Japan plans to change its asset-purchase strategy. The reversal is spurring concern the second-largest debt market is the vanguard for a broader selloff. DoubleLine Capital Chief Investment Officer Jeffrey Gundlach said investors should prepare for bonds to fall.

“The impact of the BOJ’s stimulus is that the bond markets worldwide are becoming one market,” said Chotaro Morita, the chief rates strategist at Tokyo-based SMBC Nikko Securities Inc., one of the 21 primary dealers that trade directly with the central bank. “If there’s a reversal of policy, you can’t rule out that it would roil global debt."

Treasury benchmark notes were little changed Friday with a yield of 1.61 percent as of 8:30 a.m. in London, based on data compiled by Bloomberg. The yield rose six basis points Thursday in the U.S., and Australian yields followed Friday by advancing 10 basis points to 1.96 percent.

In Japan, the 10-year benchmark climbed three basis points to minus 0.01 percent, rebounding from the record low of minus 0.3 percent set in July.

“This is a big, big moment,” DoubleLine’s Gundlach said in a webcast Thursday. “Interest rates have bottomed. They may not rise in the near term as I’ve talked about for years. But I think it’s the beginning of something and you’re supposed to be defensive.”

BOJ Governor Haruhiko Kuroda has been at the forefront of the global experimentation in monetary policy that’s extended a three-decade bull run for bonds and seen yields on as much as $8.5 trillion of developed sovereign debt languish below zero. Concern about what he’ll do next comes just as the Federal Reserve considers raising interest rates in the U.S., and as the deepest connections between worldwide markets since at least 2008 raise the stakes for central bankers and asset managers.

Steeper Curve

The BOJ chief said this week that a review of the current stimulus efforts due by the Sept. 20-21 policy meeting won’t result in a scaling back of easing. Still, some analysts and investors speculate a shift toward a steeper yield curve after the gap between two- and 30-year securities compressed to a record 30 basis points. Kuroda has noted that low long-term yields would hurt returns on pension and insurance investments.

Japan’s sway over global debt has increased in 2016. The correlation between securities in Tokyo and a gauge of worldwide bonds has risen to 0.86 this year, from 0.58 in 2015, according to Bank of America Corp. indexes. A correlation of 1 would mean they moved in lockstep.

Goldman Sachs Group Inc., a primary dealer in both the U.S. and Japan, warned in May that Japan could be the catalyst for the next international selloff in bonds. While there’s no immediate danger of a global spike in long-term yields amid tepid inflation worldwide, any shift in the BOJ’s unprecedented asset-purchase plan would have a ripple effect, according to Francesco Garzarelli, the London-based co-head of global macro and markets research.

Global Impact

“A change in tack by the BOJ would be felt on global bonds,” he said in e-mailed responses to questions on Wednesday.

In 2015, it was euro-area government debt that was in the driving seat for fixed-income markets around the world. 

Traders were caught off guard as nascent signs of inflation and euro-zone economic growth fueled a bond rout that began in Europe and quickly spread. The 10-year German yield surged by more than one percentage point in less than two months, and the Bloomberg Global Developed Sovereign Bond Index lost more than $750 billion in market value between April 29 and June 5 last year.

Japan’s government debt has tumbled 2.3 percent this quarter, heading for its steepest such loss since 2003, the BofA indexes show. Other markets have so far fared better. The premium offered by 10-year Treasuries over similar-maturity Japanese bonds shrank to the least in 17 months this week at 156 basis points, before rebounding to 164 basis points.

All this comes after the BOJ’s decision to introduce a negative deposit rate in January accelerated a plunge in yields. That spurred a rush among Japanese investors to seek income in bonds abroad -- flows that have now started to dry up. 

They sold a net 1.33 trillion yen ($13 billion) of overseas debt in the week ended Sept. 2, unloading securities for the first time since June, according to Ministry of Finance data. That was after buying 4.72 trillion yen of U.S. sovereign bonds in July, the biggest amount in ministry data to 2005 after the record 4.95 trillion yen they purchased in March.

“Japanese purchases of Treasuries have stopped temporarily,” said Hideo Shimomura, the chief fund investor at Mitsubishi UFJ Kokusai in Tokyo, which oversees about $118 billion. “Long-term yields in Japan have risen. Money will be coming back.”

Overseas buying of U.S. debt helped push 10-year yields to an all-time low of 1.32 percent in July.

Record Stimulus

Kuroda has made unprecedented use of central bank power with his package of negative interest rates along with purchases of government and corporate bonds, stock exchange-traded funds and shares in real-estate investment trusts. Any shift may fuel speculation central banks are running into diminishing returns from their use of easy monetary policies.

Old Mutual Global Investors Ltd., which oversees the equivalent of about $436 billion, says a policy change aimed at steepening the yield curve wouldn’t be surprising, even though it would come at the expense of bondholders.

“It would definitely see some pain,” said Mark Nash, head of global bonds at the London-based fund manager. “Money flows across borders. It’s all linked.”

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