Mega Banks Have Started Buying Ultra-Long-Term Government Bonds—Is the Interest Rate 'Finally Peaking'?

Former Bank of Japan official, PhD in Mathematics from the University of Tokyo, and former Chief Fixed Income Strategist at Nomura. First person in history to rank 3rd in two categories (Bonds and Securitization) in the Nikkei Veritas analyst rankings. Based on my experience of making 400 proposals a year to institutional investors, I deliver the ‘essence of finance’ that bankers and securities professionals can use directly in client talks and internal presentations. Past articles are fully available to members (free articles move to members-only two days after publication).

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The October 14th morning edition of the Nikkei featured an article titled, “‘Investment Appeal in Ultra-Long-Term Bonds,’ Says Sumitomo Mitsui FG Market Division Head.”

The content indicated that Sumitomo Mitsui FG is currently the most active among the three mega banks in investing in Japanese government bonds, and in particular, they feel there is appeal in ultra-long-term government bonds.

If the view that there is appeal in ultra-long-term government bonds is correct, it means that the rise in ultra-long-term interest rates is likely about to stop.

If the rise in ultra-long-term interest rates stops, the rise in long-term interest rates will also gradually slow down.

Also, in fact, individuals can also invest in ultra-long-term government bonds, so this article is also relevant to individual investors.

Japan’s ultra-long-term interest rates are even higher than the 10-year rate…

In Japan, 20-, 30-, and 40-year government bonds are called ultra-long-term government bonds.

At the time of writing (10/14), the 20-, 30-, and 40-year interest rates are 3.8%, 4.0%, and 4.1%, respectively.

Meanwhile, the 10-year interest rate is 3.0%.

The reason why there is not much difference in the 20- to 40-year interest rates

If you extend the maturity from a 10-year bond to a 20-year bond, the interest rate rises from 3.0% to 3.8%, but there is not much difference in interest rates beyond the 20-year bond.

This is not unique to Japan; it is the same in the United States, the United Kingdom, and elsewhere.

The background for this is the following three points, but even if you don’t understand them, it is fine to just remember that ‘ultra-long-term interest rates are roughly the same regardless of the number of years.’ 1) There is demand from life insurance companies and overseas pension funds to buy bonds with longer maturities.

2) Normally, bonds price in interest rate hikes, but since they hit a ceiling (terminal rate) at a certain point, the pricing of interest rate hikes does not change much beyond 20 years.

3) The longer the maturity, the greater the convexity (second-order approximation), so the price becomes less likely to fall (compared to calculations using duration, i.e., first-order approximation).

The Impact of Bank of Japan Rate Hikes on Ultra-Long-Term Bonds

If the Bank of Japan raises interest rates, upward pressure will be applied to government bond yields.

The impact of rate hikes is particularly pronounced for shorter maturities, such as the 2-year bond.

On the other hand, for ultra-long-term bonds like the 20-year, supply and demand (term premium) have a greater effect than the impact of rate hikes.

Therefore, even if the Bank of Japan continues to raise rates, ultra-long-term interest rates are relatively unlikely to rise (when considering only the impact of rate hikes) can be said.

Market Participants’ Views on Ultra-Long-Term Interest Rates

The Bank of Japan conducts a survey once every three months targeting government bond market participants, such as banks, insurance companies, and securities firms.

The survey items include the functionality of the government bond market and future interest rate outlooks.

The most recent survey was conducted in early August.

First, looking at the 2-year interest rate, the forecast is that rates will continue to rise until March 2029.

On the other hand, regarding the 30-year interest rate, the average forecast is that it will peak at around 4.0%, which is exactly the current interest rate level.

Even if it rises, it will be at most 4.2% (the forecast for the top 25% interest rate level), and if it falls, the forecast is that it will start to decline around the beginning of the year (the forecast for the bottom 25% interest rate level).

Trends in 30-year interest rates in other countries

Currently, U.S. 30-year interest rates have risen significantly due to fiscal concerns and other factors.

Other countries are also seeing a gradual rise, though not as sharply as in the U.S.

Since government bond yields in various countries often move in tandem to some extent, the fact that ultra-long-term interest rates are still rising globally suggests that we cannot definitively say that the rise in ultra-long-term interest rates in Japan will stop abruptly at current levels.

On the other hand, unless fiscal concerns intensify further, it would not be surprising if the ceiling for Japan’s ultra-long-term interest rates is now coming into view.

How individuals can buy ultra-long-term government bonds

Japanese ultra-long-term government bonds can be purchased as investment trusts or ETFs, even if not as individual bonds.

For investment trusts, there is

Tracers Japanese Government Bond Ultra-Long (30-year average) Quarterly Distribution Type (Amova Asset Management).

iFreeHOLD Japanese Government Bond (JGB2056) (Daiwa Asset Management).

For ETFs, there are options such as:

iShares 20+ Year Japanese Government Bond ETF (BlackRock).

and others.

Investment trusts and ETFs generally have lower trading costs (including hidden fees) compared to individual bonds, so if you are going to invest in ultra-long-term bonds, you might want to consider these options.

Also, while individual bonds are not eligible for NISA, these investment trusts and ETFs are eligible for the NISA growth investment quota.

If market interest rates were to fall by 1%, a bond with a duration of 10 years would see its price rise by approximately 10%, but a bond with a duration of 20 years would see its price rise by approximately 20%.

Because ultra-long-term bonds have both higher interest rates and longer durations compared to 10-year bonds, you can earn not only income gains but also significant capital gains, especially if interest rates fall after purchase.

However, it is necessary to be aware that the damage in the event of an interest rate hike will also be greater.

(Note) This is strictly a general theory and does not constitute a recommendation to invest in ultra-long-term bonds.

Summary

• Japanese ultra-long-term government bonds (20, 30, and 40 years) can be purchased through investment trusts or ETFs, even if not as individual bonds. They are eligible for the NISA growth investment quota, and a benefit is that trading commissions are often easier to keep lower than those for individual bonds.

• Even if the Bank of Japan continues to raise interest rates, ultra-long-term interest rates are driven more by supply and demand (term premium) than by rate hikes. It can be said that they are less affected by rate hikes than short-term rates and are relatively less likely to rise.

• In the Bank of Japan’s Bond Market Survey (August), the average forecast is that the 30-year interest rate will peak at around 4.0%.

• However, global ultra-long-term interest rates, particularly in the United States, are still rising. Interest rates in various countries tend to move in tandem, so it cannot be definitively said that they will ‘stop exactly at the current level.’ Unless fiscal concerns escalate further, it is a phase where it would not be strange to see a ceiling soon.

• Because the duration is long, capital gains when interest rates fall are significant, but it is necessary to be aware that the damage when interest rates rise is also significant (this is a general theory and does not constitute a recommendation to invest).

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Takenobu Nakajima’s Money.lab | Takenobu Nakajima (Former Bank of Japan official, PhD in Mathematics from the University of Tokyo)