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Japan's plan to issue more shorter tenor bonds calms

markets

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Latest JGB auction shows investors still expect higher

yields

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Analysts expect other governments will pile more debt at

short

end

By Vidya Ranganathan and Carolina Mandl

SINGAPORE/NEW YORK, May 28 (Reuters) - Japan, one of the

world's most indebted developed economies, this week also turned

into a saviour of sorts for its own bond market and globally.

When Reuters reported on Tuesday Japan's ministry of finance

(MOF) may reduce issuance of super-long tenor debt, bond markets

from Japan and South Korea to Britain and the United States

reacted positively, pushing prices up and yields down.

That paused the weeks-long bond selloff forced by investors

demanding bigger yields as they braced for increased inflation

and government spending caused by U.S. President Donald Trump's

trade and tax policies.

Yields on 40-year Japanese government bonds

(JGBs) had hit a record high 3.675% last week and were down 40

basis points from that level. Yields on 30-year U.S. Treasuries

dropped to below a key 5% figure, helping the yield

curve turn less steep.

Michael Lorizio, managing director and head of U.S. rates at

Manulife Investment Management, said Japan's proposal had

stabilised all developed government debt.

"As deficits expand, this will be a test case for other

countries, if being more flexible around how issuance is

scheduled is an attractive option, or not."

Japan would be a test case for the entire world on the best

way for governments to handle "signs of stress or a mismatch

between supply and demand," Lorizio said.

As of Wednesday, going by the auction of 40-year JGBs,

investors aren't sold on the idea. Demand at the auction was at

its weakest since July. A week ago, investors eschewed a 20-year

bond auction so badly it was Japan's worst auction result since

2012.

"For now, we have more orderly markets and some time for

markets to catch their breath but, in the big picture, it's a

band-aid," said Tom Nakamura, vice-president and head of fixed

income & currencies at Canadian fund AGF Investments.

"All these things are meant to help market functioning in

the short term, but do very little to alleviate concerns in the

medium- to long-term because the underlying causes of those

concerns haven't gone away and are not helped by increasing

funding from shorter-term instruments," he said.

Nakamura said his portfolio has changed to limit exposure to

long-end bonds and diversify into markets with healthier fiscal

settings or more attractive yields, such as Germany, Poland and

Romania.

RECOGNISING RISKS

Japan isn't alone. Britain's debt agency told Reuters in

March there would be an "important shift" away from long-dated

debt in the coming financial year in response to rising

borrowing costs and reduced investor demand.

Britain plans to issue 299 billion pounds ($402.60 billion

of government bonds this year - the second highest amount on

record - and its bonds have come under pressure from concern

about high debt levels and bond issuance.

Japan's situation is more complicated than elsewhere as its

debt is 2-1/2 times the size of the economy and its central bank

has slashed its previous bond buying.

That governments are retooling their debt and fund-raising

plans shows they are listening to markets, rather than letting

central banks manage yields through monetary tools, analysts

said.

"What surprised us as well as the market was that we didn't

really expect the Ministry of Finance to be the one that moves

and starts discussing changes in issuance," said Subadra

Rajappa, head of U.S. rates strategy at Societe Generale.

While the U.S. Treasury has for years gradually shortened

the duration of its debt by issuing more short-term bills as

longer term bonds mature, overall debt has been rising.

If Trump's "big, beautiful bill" on taxes is passed in the

coming days, it is estimated to add about $3.8 trillion to the

federal government's $36.2 trillion in debt over the next

decade.

When Moody's Investors' Service downgraded the U.S. rating

this month, it projected U.S. public debt, now around 100% of

gross domestic product, will rise to 134% over the next decade.

"The Treasury is finding that the market doesn't have an

appetite for anything at the long end of the curve unless the

rate is above 5%," said Eric Beyrich, co-chief investment

officer at Sound Income Strategies. "That will force them back

to the short end of the curve when it comes to new issues."

Germany is the only G7 economy with a debt-to-GDP ratio

below 100%, yet investors have also sold its bonds in recent

months on expectations of more supply following the surprise

creation of a 500 billion euro ($565 billion) infrastructure

fund.

"The market is sending a signal that concerns are growing

around fiscal and debt sustainability," said Chip Hughey,

managing director of fixed income at Truist Advisory Services in

Richmond, Virginia.

"Market participants want to see policymakers use a

multi-pronged approach to address deficits and lower their

reliance on debt issuance."

($1 = 0.8846 euros)

($1 = 0.7427 pounds)