Japan bond market functioning improves slightly, yields seen rising

The Bank of Japan's latest survey reveals a marginal improvement in the functioning of the secondary Japanese Government Bond market, yet overall sentiment remains cautious.

The Diffusion Index (DI) for market functioning improved by 13 points from three months ago, but the current situation DI stands at -16, with 68 percent of respondents describing functioning as 'not very high' and 29 percent as 'low'.

Bid-ask spreads are still perceived as wide by 34 percent of participants, and 20 percent reported a widening over the past three months.

Similarly, order quantities are considered small by 38 percent of respondents, with 20 percent observing a decrease.

Despite these challenges, dealing frequency saw a slight positive shift, with its DI improving by 4 points, and 13 percent of firms reporting an increase.

A quarter of respondents indicated they could make dealings with expected prices, and 32 percent with expected dealing lots, suggesting some pockets of stability.

Survey participants anticipate a gradual upward trend in Japanese Government Bond yields across all maturities over the next three years.

The average forecast for the newly issued 2-year JGB yield rises from 1.42 percent at end-June 2026 to 1.83 percent by end-March 2029.

For the benchmark 10-year JGB, the average yield is projected to increase from 2.50 percent to 2.77 percent over the same period.

The probability distribution forecast for the 10-year JGB yield at end-March 2029 shows the highest concentration (24.8 percent) in the 2.76-3.00 percent range, reinforcing expectations of higher rates.

This outlook suggests a continued normalization of the yield curve.