Japanese megabanks pile on short-duration bonds ahead of expected rate rises

Buildings in Tokyo's Shinjuku area.

Source: samxmeg/E+ via Getty Images.

Japan's megabanks have allocated more funds to shorter-duration bonds in recent quarters as they prepare for an expected increase in interest rates in the world's third-biggest economy.

Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. have all reduced the average length of their bond maturity with the move to shorter-duration bonds, according to information from the three largest lenders. A shift in the Bank of Japan's monetary policy stance could happen as early as this month, according to analysts.

The banks "are preparing for higher interest rates as everybody believes interest rates will go up," said Toyoki Sameshima, a senior analyst at SBI Securities. The banks will keep more of short-term bonds and less of the longer maturities, Sameshima said.

Short-duration moves

Mizuho increased its portfolio of Japanese government bonds maturing in less than one year to ¥14 trillion in March from ¥10.9 trillion in December 2022, according to a May 15 company filing. It also cut holdings of mid- and long-term Japan Government Bonds (JGBs) to ¥2.4 trillion from ¥3.8 trillion. The average duration of the bonds was cut to 0.7 year from 1 year.

Mitsubishi UFJ, the country's biggest lender by assets, increased its holdings of JGBs maturing in one to five years to ¥11 trillion as of March 2023, from ¥8.9 trillion in September 2022. It simultaneously cut the holdings of five-to-10-year JGBs to ¥4 trillion from ¥4.6 trillion, according to bank filings. Its holdings of JGBs maturing in less than a year stood at ¥20.8 trillion, versus ¥21.2 trillion. The average duration of the JGBs it holds declined to 1.5 years from 1.9 years.

SMFG, the other Japanese megabank, cut the average duration of Japanese government and corporate bonds it held to 2.4 years at the end of March 2023, from 2.8 years a year ago, according to a May 15 filing. The bank did not provide a breakdown by types of bonds.

Rising interest rates make bonds, which pay a fixed coupon rate, relatively less attractive for investors. Longer-term bonds are typically more sensitive to rates fluctuations than bonds that are closer to maturity.

Policy shift

Kazuo Ueda, who took over as Bank of Japan governor in April, has previously reiterated that the central bank will keep its ultraloose monetary policy settings until the economy achieves a 2% inflation target on a stable basis. Japan's consumer price index rose 3.2% year over year in May, the inflation rate staying above 3.0% for nine consecutive months. CPI inflation had hit as high as 4.2% in January, well above the Bank of Japan's target. That comes after inflation stayed below 2% since 2015, with the economy even slipping into deflation during the pandemic.

All eyes are on the central bank's next monetary policy meeting on July 27 and July 28 as expectations build that the central bank will again tinker with its yield curve control policy as a precursor to abandoning negative interest rates, possibly in 2024. The country's rates have been held at -0.1% since 2016.

The Bank of Japan surprised markets in December 2022, when it expanded its target band of long-term yields to 0.5% from 0.25%, effectively allowing long-term interest rates to rise.

"Financial institutions are taking a position and bracing for the amendment in yield curve control," said Ryutaro Kono, senior economist at BNP Paribas Japan. Kono expects the central bank to expand the target band for the long-term yield to 1.0% from the current 0.5% at the policy meeting later this month.

Interest income boost

The moves follow unrealized and actual losses Japanese megabanks suffered from their investments in foreign bonds, mainly US Treasurys, as interest rates in the rest of the world increased.

Any increase in interest rates in Japan will, however, help banks improve their net interest margins. MUFG said at its investor conference in May that an end to negative rates and a rise in mid- and long-term yields could add more than ¥50 billion a year to its profit through higher interest income.

An increase of short-term yields from -0.1% to 0% will generate ¥30 billion a year in lending profit for SMFG, while Mizuho expects such a rise to bring in ¥20 billion, according to estimates the lenders provided earlier this year.

As of July 17, US$1 was equivalent to ¥139.00.