Weak JGB auction revealing how hard it will be for BoJ to exit its ultra lax policy

The first bond auction held for the 10-year JGB on January 10th ran into the weakest demand in almost four years. The difference between the average accepted price and the lowest accepted price was the largest since March 2020, which signifies a weak auction.

One of the reasons behind the weak demand for JGBs is the falling bond yield from the beginning of the new year. After a massive earthquake hit the Noto peninsula region on the New Year’s Day, the market expectation that the BoJ might make a move at the January meeting completely disappeared. Arguably, the BoJ should be on standby to provide additional liquidity during an emergency, rather than reducing stimulus.

These developments highlight one of the challenges the BoJ would face this year while pondering the exit from negative rates and yield curve control (YCC). In fact, the JGB redemption is expected to be elevated close to JPY 150 tr in FY24 (Chart 1) which is likely to be refinanced by issuing JGBs. Japan’s Ministry of Finance has increasingly rolled over debt by issuing refinancing bonds (Chart 2), supported by the YCC as well as the negative policy rate.

With this background, the BoJ’s ultra-accommodative policy may not end up stimulating investment appetite for JGBs, at a time when the issuance needs are huge. This means that yields could suddenly surge (and not necessarily because of a push from Fed policies as in 2023). Surging bond yields could raise serious questions on public debt sustainability, as Japan has the highest public debt ratio among developed economies*.

Therefore, the BoJ will need to be very careful when adjusting its currently ultra-low monetary policy given Japan’s fiscal position. At the same time, falling global bond yields thanks to a more dovish Fed could provide some respite for the BoJ and yet, the stubbornly strong labor market data in the US show how uncertainty the Fed’s path for next year remains.

* Full list of opeds together with other publication summaries can be found at Substack (https://aliciagarciaherrero.substack.com/).

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