The situation surrounding 10-year floating-rate Japanese government bonds for individuals amid a pause in interest rate hikes.
Is it okay to buy the 10-year floating rate bond?
Is it okay to buy the 10-year floating rate government bond for individuals in the current interest rate environment? Today, I would like to consider that.
Since the applicable interest rate for the 10-year floating rate bond is reviewed every six months, if interest rates rise in the future, the interest received will increase accordingly. However, in a phase where interest rates have already risen to a certain extent, as they have now, a different perspective is required.
The different perspective is ‘the possibility that interest rates will fall within the next few years’.
If interest rates continue to rise, there is a significant advantage to buying the 10-year floating rate bond. However, if interest rates peak and then begin to decline, it would have been better to choose a fixed-rate product.
So, in the current interest rate environment, is it okay to buy the 10-year floating rate bond?
1. The 10-year bond yield is being repelled near 3%
When considering current interest rate trends, what is important is the future movement of the 10-year government bond yield.
The 10-year government bond yield rose significantly, at one point exceeding 3%. However, it then fell sharply, showing a movement of being repelled near 3%. Is 3% the upper limit of the range? It looks that way.
However, isn’t the correct way of thinking that just because it has been repelled several times in the past, it does not necessarily mean that the rise will stop at 3% in the future? This is because there is no clear ceiling for interest rates, and if economic conditions or monetary policy change, it may break through the levels that have been conscious until now.
Even so, it is possible that the 3% level is being conscious in the market. After all, it is a nice round number, and in the Japanese situation, for example, the inflation rate is currently around 2%, and a 3% level that exceeds the inflation rate is a figure that beats inflation and also increases. It is no wonder that many investors think the 3% figure is worth investing in.
What I want to consider here is the problem of whether the 3% level will be the upper limit in this interest rate rise phase, or whether it will eventually be broken through.
If the 3% level becomes the upper limit and interest rates remain flat or decline in the future, the reason for actively choosing the 10-year floating rate bond becomes a little weaker.
Conversely, if it breaks through 3% and rises further, the appeal of the 10-year floating rate bond will increase.
In the end, whether or not to buy the 10-year floating rate bond cannot be separated from the question of how future interest rates will move.
2. Will 3% be the upper limit? That is unknown
So, will the 10-year government bond yield peak out near 3%?
Honestly, this is unknown. This is because there are convincing materials for both the reasons why interest rates will rise and the reasons why interest rates will fall.
First, considering the possibility that interest rates will rise further, there are several reasons for this.
If price increases continue longer than expected, as they are now, additional interest rate hikes by the Bank of Japan will be conscious. If the view that policy interest rate hikes will continue strengthens, upward pressure is also likely to be applied to the 10-year bond yield.
Concerns about fiscal deterioration also remain important. If the 10-year bond yield rises, various reports will emerge, such as ‘the government has no concrete financial resources’ or ‘is fiscal policy safe with all this spending?’ Such speculation will ignite the market again, leading to a trend of rising interest rates.
Furthermore, overseas interest rate trends cannot be ignored. Since fiscal concerns are a common topic among developed countries, concerns will rise somewhere in Europe or the United States. If the environment globally becomes one where long-term interest rates are prone to rising, it could also affect Japan’s long-term interest rates.
If these factors overlap, a scenario where the 10-year government bond yield rises above 3% is quite conceivable.
So, what are the reasons for interest rates to fall?
It is the speed of the Bank of Japan’s interest rate hikes. Until recently, it was reported that ‘consecutive rate hikes in September and October are likely,’ but when it came down to it, there was no rate hike in October, and no consecutive hikes. The Bank of Japan has signaled a stance of ‘wanting to assess the impact after the rate hike.’ Even if the market assumes consecutive rate hikes and expects interest rates to rise rapidly, in reality, the Bank of Japan seems to be adding a cushion by watching the economic situation and movements in the world. Therefore, if the movement becomes calm without a fast pace of rate hikes—waiting to see how things go—it will differ from market expectations, and there is a possibility that downward pressure will be applied to long-term interest rates.
Also, as is the case now, for example, if doubts are cast on AI investment, investors become cautious, and demand for government bonds, which are considered safe assets, increases, it can lead to a rise in bond prices and a fall in yields.
As such, there are convincing reasons for both the scenario where interest rates fall and the scenario where they rise.
At this point, it is difficult to judge that one is overwhelmingly more likely than the other, which is precisely why it is difficult to think about whether future interest rates will rise or fall, and whether it is okay to buy the 10-year floating rate bond.
3. If the outlook for interest rates is subtle, how should one think about the 10-year floating rate bond?
Thinking this far, it becomes increasingly difficult to judge whether or not to buy the 10-year floating rate bond.
If you think interest rates will rise, choose the 10-year floating rate bond. If you think interest rates will fall, choose a fixed-rate product.
The logic is easy to understand, but in reality, it is difficult to accurately predict future interest rate trends.
However, personally, even considering the possibility that future interest rates will fall, I do not think it is necessarily required to assume a significant drop in interest rates. This is because, considering the current situation, structural inflationary pressures such as inflation caused by labor shortages remain, and it is thought that the central bank needs to maintain policy interest rates to a certain extent.
However, depending on economic and price trends, there is a possibility that interest rates will fall beyond current market expectations. Interest rates can easily return to the low levels they were at before.
It is a bit messy, but the point is that I want to consider the scenario where future interest rates remain at a somewhat high level as one of the options. Also, since it is said that the Bank of Japan’s policy interest rate might reach 1.5% to 2.00%, the scenario where interest rates rise still remains.
In such an environment, I still believe there is a certain rationality in purchasing and holding the 10-year floating rate bond.
I think the 10-year floating rate bond is worth considering in terms of responding to interest rate hikes, and since interest rates do not necessarily fall, I think it is okay to hold it in that respect as well.
4. There is also the option of a 5-year fixed rate bond
In the current interest rate environment, one should naturally also consider the ‘5-year fixed rate’ individual government bond.
For the 5-year fixed rate bond, the interest rate applied at the time of purchase does not change until maturity.
Therefore, even if market interest rates rise after purchase, the interest you receive will not increase. Conversely, even if market interest rates fall, the interest rate at the time of purchase is maintained.
Therefore, if you believe that future interest rates will remain flat or decline, the 5-year fixed-rate bond has its appeal.
Compared to the 10-year floating-rate bond, where the applicable interest rate changes every six months while you worry about future interest rate trends, there is also the benefit of being able to plan your finances more easily and feel more secure by locking in the interest rate at the time of purchase.
If you are satisfied with the current interest rate of the 5-year fixed-rate bond, the idea of securing that rate without trying to predict future interest rates is quite reasonable.
Of course, if interest rates rise significantly after purchase, it would have been more advantageous to have chosen the 10-year floating-rate bond.
Ultimately, which is more advantageous, the 5-year fixed-rate or the 10-year floating-rate bond, depends on the interest rate trends after purchase.
However, precisely because future interest rates are unpredictable, it is worth including fixed-rate bonds in your comparison rather than focusing solely on floating-rate bonds.
5. If you are investing for 10 years, the 10-year new over-the-counter government bond is also an option.
Another option you might want to consider is the “10-year new over-the-counter government bond.”
Although it is a product with the same 10-year term, the 10-year floating-rate bond has its applicable interest rate reviewed every six months. On the other hand, the 10-year new over-the-counter government bond has a fixed interest rate, and if held until maturity, you will receive interest based on the rate determined at the time of purchase.
Basically, the interest rate is higher for the new over-the-counter government bond.
However, the selling price of the 10-year new over-the-counter government bond fluctuates depending on market interest rates and other factors. If interest rates rise after purchase, the bond price will fall, and there is a possibility that you will lose principal when selling.
This point is significantly different from government bonds for individuals, which can generally be redeemed early at face value.
Therefore, if you think, “Won’t market interest rates rise much in the future?”, the 10-year new over-the-counter government bond has a higher interest rate than the 5-year fixed-rate or 10-year floating-rate bonds, so it is worth considering.
If you are investing for the same 10-year period, the new over-the-counter government bond might also be a candidate.
6. In the end, is it okay to buy the 10-year floating-rate bond?
As we have seen so far, in the current interest rate environment, it is not easy to judge definitively that the 10-year floating-rate bond definitely has advantages, or conversely, that it has too many disadvantages.
Will the 10-year government bond yield peak out around 3%, or will it break through that level and rise further? Or will economic and price trends change, causing interest rates to fall?
There is a reasonable basis for every scenario. Therefore, it is difficult to make a judgment that predicts the future of interest rates at a single point and bets on it.
Personally, I do not think it is necessary to focus only on the possibility that future interest rates will fall significantly. As long as there is a possibility that interest rates will remain at a somewhat high level, there is a certain rationality in choosing the 10-year floating-rate bond.
The important thing is not just to guess whether future interest rates will rise or fall, but to choose based on how much interest rate fluctuation you can tolerate and when you plan to use the funds.
Is it okay to buy the 10-year floating-rate bond?
My answer is, I think it is okay to buy it. However, there is no need to limit yourself only to the 10-year floating-rate bond.
Precisely because it is difficult to predict the future of interest rates now, it is a good idea to compare the 10-year floating-rate bond, the 5-year fixed-rate bond, and the 10-year new over-the-counter government bond, and choose based on their respective characteristics.