BNP Paribas Asset Management is increasing its exposure to long-dated Japanese government bonds, attracted by elevated yields, a steep yield curve and strengthening evidence that domestic institutional investors are returning to the market.
The investment strategy comes as Japan’s government bond market shows signs of recovering demand after months of volatility driven by inflation, fiscal uncertainty and expectations of further monetary tightening by the Bank of Japan.
Ryutaro Kimura, senior bond strategist at BNP Paribas Asset Management, has identified improving demand from domestic investors, particularly life insurance companies, as an important development supporting longer-maturity government securities.
The strongest indication emerged at Japan’s 20-year government bond auction on Tuesday, when demand reached a record level. The bid-to-cover ratio climbed to 5.84, compared with 4.01 at the previous auction and a 12-month average of 3.73.
The exceptionally strong bidding reflected renewed appetite for securities offering higher returns than those available during Japan’s prolonged period of exceptionally low interest rates.
Kimura attributed the favourable auction outcome to recovering domestic demand, supported by elevated interest rates and easing concerns about the government’s fiscal position.
Japanese life insurers have increased their net purchases of super-long government bonds since June, providing additional evidence that institutions with long-term liabilities are rebuilding their holdings of domestic fixed-income assets.
The auction results also showed an improvement in pricing conditions. The difference between the average accepted price and the lowest accepted price narrowed to 0.07 from 0.15 at September’s sale, indicating stronger bidding competition.
The yield on 20-year government bonds subsequently declined by as much as six basis points to 3.710%, reflecting the immediate market response to the auction.
Japan’s yield curve remains unusually steep, offering investors considerably higher returns on securities with longer maturities. That difference has encouraged asset managers to reassess the balance between income opportunities and the risks associated with holding longer-duration bonds.
Official yield data showed the benchmark 10-year government bond yielding approximately 2.93% on October 20, compared with 3.99% for the 30-year maturity. The difference exceeded one percentage point, highlighting the additional compensation available to investors extending their investment horizons.
Longer-duration bonds also carry greater sensitivity to changes in interest rates. Their prices can fall sharply when yields rise, making portfolio positioning particularly important while monetary policy expectations remain unsettled.
Japan’s central bank is expected to remain a significant influence on market conditions. Investors are awaiting its next policy meeting for indications about the pace of further interest rate increases and the outlook for inflation.
The Bank of Japan’s policy rate stood at 1.25% in October, following successive adjustments intended to address persistent inflationary pressures. Further tightening could influence borrowing costs across the maturity spectrum, although movements in longer-term yields also depend on government borrowing requirements and investor demand.
BNP Paribas Wealth Management’s October fixed-income outlook anticipates additional monetary tightening by the Japanese central bank, with approximately quarterly increases and a terminal policy rate around 2.5% in 2028. That projection represents the institution’s assessment rather than an announced central bank policy path.
Government financing requirements remain another consideration for investors. Prime Minister Sanae Takaichi’s administration faces scrutiny over fiscal proposals and their implications for future bond issuance, particularly as higher yields increase the cost of financing public debt.
Nevertheless, improved auction demand suggests that higher interest rates are attracting buyers who previously found Japanese government securities insufficiently rewarding.
The potential return of domestic capital is particularly significant because Japanese banks and insurers have substantial overseas bond investments. Rising domestic yields can encourage these institutions to reconsider foreign allocations, especially where currency hedging reduces the returns available from overseas securities.
Japanese investors sold foreign bonds for a fifth consecutive week through October 17, with cumulative net disposals reaching approximately ¥3.43 trillion over that period. The withdrawals provide further evidence of changing investment preferences as domestic fixed-income yields become more competitive.
The Ministry of Finance has also adjusted issuance arrangements for longer-maturity securities, an important consideration for investors assessing the relationship between government bond supply and institutional demand.
Market participants will continue examining auction results alongside investment plans from major insurers to assess the composition of demand. Japan’s Ministry of Finance conducted another liquidity-enhancement auction on October 22, following its 20-year government bond sale earlier in the week.
