Credit: Land of the Rising Yields – Influence on Longer-dated USD Bonds
Focusing on high quality credit in the 3-5Y segment is the sweet spot amid policy uncertainty
Chief Investment Office, Daryl Ho27 Jan 2023
  • The BOJ continues to implement accommodative monetary policy, despite signs of rising inflation
  • Policy normalisation would render domestic Japanese assets more attractive than foreign investments
  • Since 2022, high US rates have made currency-hedged USD bonds unattractive for Japanese investors
  • Fixed income investors should not be complacent with duration risk
Article image
Photo credit: iStock
Read More

Japan’s inflation conundrum. The Bank of Japan (BOJ) gave the world a Christmas shock in 2022 by widening the trading band for 10Y JGB yields from ±25 bps to ±50 bps about zero under its yield curve control (YCC) framework – no doubt showing that it can no longer stand idly by while its citizens deal with the rise in domestic prices. Apparently, even an economy famed for its secular stagnation – for which the term “Japanification” came about – was no longer immune to the inflationary pressures that have engulfed the globe. Notably, Japan’s CPI rates are at highs not seen for the last 30 years.

Policy at odds with reality. Such price pressures make the YCC policy – where the BOJ purchases whatever quantity of JGBs it takes to keep 10Y yields near 0% – look increasingly anachronistic; unsuited for the times they are in. As the rest of the world raced to tighten monetary policy, the BOJ worked in reverse; in effect sacrificing the JPY to support their bond markets and resulting in the c.30% decline of the JPY against the USD at its peak in 2022. While famed for being an export juggernaut in the 1980s, today’s Japan is more import reliant, and the weaker yen only stands to (a) raise imported inflation and (b) widen the already significant trade deficit observed in 2022.

The impending great unwind. The facts suggest that an exit of accommodative policy is not a matter of if, but when; given that it is no longer beneficial to have an ever-weakening yen. Yet it is difficult to imagine a stoppage or reversal of decades of QE without important financial consequences. To give perspective on the task at hand, consider that the US Fed is currently “only” reducing its balance sheet by USD95b a month (or USD1.14t a year, approximately 4.4% of annual GDP) to taper excess bank reserves. Given reserve balances of c.USD3.1t, this would take them c.33 months to bring said reserves to zero.

The BOJ, on the other hand, has amassed a gargantuan JPY451t in excess reserves. To normalise policy at the same rate as the US would imply the reduction of c.JPY164t in JGBs per year, a massive 30% of annual GDP – close to seven times the US amount in %-GDP terms. Put another way, should Japan begin normalisation immediately at the same pace as the US (in %-GDP terms), it would still take more than 18 years from today to reduce excess reserves to zero.

The unnoticed risk for bonds. It is no wonder then that policy change is consistently met with such inertia. That, however, does not absolve the fact that inflationary pressures continue to mount in the background, as large Japanese corporates are already planning sizeable domestic wage increments from this year onwards (e.g. Uniqlo, a Japanese casualwear brand announced pay increments of up to 40% for about 8,400 employees), introducing further threats of a potential wage-price spiral. We believe that the upward pressure on yields in Japan is an under-appreciated risk for fixed income investors, warranting caution on long duration exposure.


Download the PDF to read the full report.



This information herein is published by DBS Bank Ltd. (“DBS Bank”) and is for information only.  This publication is intended for DBS Bank and its subsidiaries or affiliates (collectively “DBS”) and clients to whom it has been delivered and may not be reproduced, transmitted or communicated to any other person without the prior written permission of DBS Bank. 

This publication is not and does not constitute or form part of any offer, recommendation, invitation or solicitation to you to subscribe to or to enter into any transaction as described, nor is it calculated to invite or permit the making of offers to the public to subscribe to or enter into any transaction for cash or other consideration and should not be viewed as such.

The information herein may be incomplete or condensed and it may not include a number of terms and provisions nor does it identify or define all or any of the risks associated to any actual transaction. Any terms, conditions and opinions contained herein may have been obtained from various sources and neither DBS nor any of their respective directors or employees (collectively the “DBS Group”) make any warranty, expressed or implied, as to its accuracy or completeness and thus assume no responsibility of it. The information herein may be subject to further revision, verification and updating and DBS Group undertakes no responsibility thereof.

All figures and amounts stated are for illustration purposes only and shall not bind DBS Group. This publication does not have regard to the specific investment objectives, financial situation or particular needs of any specific person. Before entering into any transaction to purchase any product mentioned in this publication, you should take steps to ensure that you understand the transaction and has made an independent assessment of the appropriateness of the transaction in light of your own objectives and circumstances. In particular, you should read all the relevant documentation pertaining to the product and may wish to seek advice from a financial or other professional adviser or make such independent investigations as you consider necessary or appropriate for such purposes. If you choose not to do so, you should consider carefully whether any product mentioned in this publication is suitable for you.  DBS Group does not act as an adviser and assumes no fiduciary responsibility or liability for any consequences, financial or otherwise, arising from any arrangement or entrance into any transaction in reliance on the information contained herein.  In order to build your own independent analysis of any transaction and its consequences, you should consult your own independent financial, accounting, tax, legal or other competent professional advisors as you deem appropriate to ensure that any assessment you make is suitable for you in light of your own financial, accounting, tax, and legal constraints and objectives without relying in any way on DBS Group or any position which DBS Group might have expressed in this document or orally to you in the discussion.

Any information relating to past performance, or any future forecast based on past performance or other assumptions, is not necessarily a reliable indicator of future results.

If this publication has been distributed by electronic transmission, such as e-mail, then such transmission cannot be guaranteed to be secure or error-free as information could be intercepted, corrupted, lost, destroyed, arrive late or incomplete, or contain viruses. The sender therefore does not accept liability for any errors or omissions in the contents of the Information, which may arise as a result of electronic transmission. If verification is required, please request for a hard-copy version.

This publication is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

If you have received this communication by email, please do not distribute or copy this email. If you believe that you have received this e-mail in error, please inform the sender or contact us immediately. DBS Group reserves the right to monitor and record electronic and telephone communications made by or to its personnel for regulatory or operational purposes. The security, accuracy and timeliness of electronic communications cannot be assured.