With yields of just 1% or 2% even at the long end of the curve and continuing concerns on oversupply...
With yields of just 1% or 2% even at the long end of the curve and continuing concerns on oversupply, fixed interest managers are bearish on Japanese government bonds (JGBs).
Massive issuance from successive fiscally undisciplined Japanese governments has made Japan the largest single-country issuer in the global bond indices, with a weighting of around 30%.
But few fund managers are willing to place so much of their portfolio in bonds with such limited upside potential.
Stewart Cowley, a manager in Newton's global fixed interest team, has no JGBs in the Newton International Bond fund and sees no prospect of buying any in the medium term. 'In terms of total return, there is limited downside in yields and a systemic decline in the yen. It makes no sense at all to have anything other than a very small amount in Japan,' he says.'You may want to hold Japan from time to time for risk management reasons, but if it wasn't for the index weighting, you generally just wouldn't hold them at all.'
Cowley says, with the Japanese population forecast to peak in the next few years, the old will become increasingly dependent on government financial support, which will make it extremely difficult for the government to repay debt or even slow the pace of issuance.
In May, Standard & Poor's and Moody's downgraded their credit ratings for yen-denominated Japanese sovereign debt.
'The political machine of Japan is against reform, and until you solve that problem you won't get significant movement because there are too many vested interests within the Japanese political system,' Cowley says.
'The only positive thing happening in the economy is a process of managed depreciation of the yen in the medium term in order to give Japan some sort of competitive edge.'
While a weaker yen may make Japan's exports more attractive to foreign buyers, it is hardly a selling point for foreign investors into Japan who will either be forced to take out currency hedging ' at a price ' or watch the value of their Japanese holdings erode in US dollar terms.
Gareth Fielding. director of fixed interest at Merrill Lynch, says the short-term outlook on Japanese bonds is distorted by the approach of the fiscal half-year end on 30 September.
'International investors are speculating that Japanese domestic investors are hiding out in fixed income, avoiding the carnage in equities,' he says.
'But once we get through the half-year end, they may book some of those profits and move their cash elsewhere.'
The Merrill Lynch Global Bond fund is underweight on JGBs and Fielding remains negative over the medium term. Unlike Cowley, however, Fielding expects some improvement in the Japanese economy, with export orders rising in recent months, money supply surprising on the upside and growth in monthly machinery orders.
'With a stronger economy as we go into the end of the year, we would expect to see a bounce in equities, and some of the investors sitting in fixed income may move back to their more natural home, which is as equity investors,' he says.
'As we get into next year I expect the pressure of supply and very gently improving fundamentals to weigh on the market and push yields a little higher.'
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