January 24, 2023 | Stamford, CT — Japanese fixed-income investors may consider revisiting some long-established trading practices after the Bank of Japan (BOJ) took what could be the first small step toward unwinding its near decade-long policy of ultra-low interest rates.
In December 2022, the BOJ raised the cap on benchmark 10-year government bond yields. Although the BOJ stood pat in its January meeting, many in the market still see the December move as a possible test or even the beginning of what could be a move toward monetary tightening.
“The repercussions from the BOJ action could prompt Japanese fixed-income investors to reassess not only their portfolio strategies, but also the practices and mechanisms used to trade and source liquidity in fixed-income products,” says Parijat Banerjee, Head of Asia-Pacific at Coalition Greenwich and co-author of Signs of Possible Competitive Shifts in Japanese Fixed Income.
In Japan, only 17% of investors trade Japanese government bonds electronically and only 2% use electronic execution for yen credit cash bonds. In an era of tighter monetary policy, increased volatility and wider spreads, Japanese institutions could benefit from exploring a broader use of electronic execution to access to a range of dealers and liquidity providers, both domestically and from around the world.
As fixed-income markets become increasingly digital, U.S. institutional investors are using technology to enhance trading practices and strategies, and more than three-quarters are adopting “quantimental” investment approaches supported by quantitative tools powered by cloud computing, artificial intelligence and even distributed ledger technology (DLT).
“These innovations, which are all enabled by the broader use of electronic trade execution, illustrate techniques and alternatives that Japanese institutions could explore as a means of optimizing trading outcomes in an era of tighter monetary policy, increased volatility and wider spreads,” says Seiji Ishii, Head of Japan at Coalition Greenwich, and co-author of the report.
More Diverse Dealer Lists
In addition, faced with the prospect of more challenging market conditions, Japanese investors might start examining the length and depth of their fixed-income counterparty lists. In the wake of last year’s rate hikes by the U.S. Federal Reserve, institutions in the United States, Europe and Asia ex-Japan began reaching out to new dealers who could serve as valuable alternative liquidity sources in difficult markets.
“If the trend seen in other markets holds true, Japanese investors could start searching for opportunities to diversify these counterparty lists to the extent possible in preparation for a shift in the market environment,” says Seiji Ishii.
Signs of Possible Competitive Shifts in Japanese Fixed Income explores the results of a recent Coalition Greenwich research study conducted with over 1,000 fixed-income investors globally. Topics included dealer relationships, volume allocation factors and use of electronic trading.