Japan Megabanks Signal Return to JGBs as Yield Outlook Improves Despite Valuation Losses

Gerik

Summary:

Japan’s largest banks are preparing to gradually increase their Japanese government bond holdings as yields stabilize and income prospects improve, even as unrealized losses on existing bond portfolios remain elevated....

Shift In Strategy As Yield Environment Changes

Japan’s biggest lenders are signaling a potential turning point in their long-standing retreat from Japanese government bonds. After years of reducing exposure due to ultra-low interest rates, both Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group say they are ready to rebuild JGB holdings as rising yields begin to offer more attractive returns.

Over the past decade, the banks had steadily trimmed their bond portfolios because returns were compressed under the Bank of Japan’s prolonged accommodative policy. That backdrop is now shifting, as higher interest rates improve the income outlook for government debt, prompting management teams to reassess their positioning.

Recent Yield Volatility And Market Stabilization

JGB yields climbed sharply from November, a move linked to fiscal expansion expectations following spending plans outlined by Prime Minister Sanae Takaichi. The surge weighed on bond valuations, pushing unrealized losses higher across bank balance sheets. However, market conditions have calmed in recent weeks.

Demand at the last four government debt auctions has been resilient, and the 30-year JGB yield has fallen by 32 basis points from its January 20 record high of 3.88%. This easing has helped stabilize expectations and reduced immediate pressure on bond prices.

Takayuki Hara, managing director and head of the CFO office at MUFG, said the bank would move carefully but sees scope to rebuild positions as long-term rates show signs of peaking.

Unrealized Losses Remain A Key Constraint

Despite the improved outlook, valuation losses remain substantial. MUFG reported unrealized losses of 200 billion yen on its bond portfolio at the end of the year, sharply higher than the 40 billion yen recorded at the end of March. The bank noted that sales of longer-duration bonds between September and December helped limit further damage.

SMFG faces a similar situation. Its unrealized losses on JGBs more than doubled to 98 billion yen over the nine months to December. Management acknowledged the impact of rising yields on bond prices but emphasized plans to increase holdings gradually while monitoring market conditions.

The experience highlights a structural challenge for banks: when yields rise, bond income improves over time, but the immediate effect is a decline in the market value of bonds purchased at lower rates. This relationship is a valuation effect rather than a deterioration in credit quality.

Duration Strategy And Cautious Re-Entry

In recent years, Japan’s megabanks have favored short-duration bonds to limit interest rate risk. Mizuho Financial Group, the third-largest lender, reported an average remaining maturity of just 1.8 years for its JGB holdings at the end of December.

Analysts expect this cautious stance to persist in the near term. Further rate hikes by the Bank of Japan and concerns over Japan’s large public debt load could still push yields higher, making banks reluctant to add longer-duration exposure too quickly.

Some market participants see a clearer entry point later. Toshinobu Chiba of Simplex Asset Management said the JGB yield curve could continue to rise, with the 10-year yield potentially reaching 2.5%, compared with its current level of around 2.195%. Such a move could offer a more compelling risk-return balance for banks.

Earnings Momentum Supported By Higher Rates

The broader rate environment has already boosted profitability across the sector. The Bank of Japan raised rates for the first time in 17 years in March 2024 and has delivered three additional hikes since, taking the policy rate to 0.75%. That shift has helped Japan’s megabanks forecast record profits for the current financial year.

Equity markets have reflected this improvement. The Topix banking index has doubled since the initial rate hike in March 2024, far outperforming the broader Topix index’s 33% gain.

Looking further ahead, analysts see scope for higher yields on longer-duration JGBs to support earnings growth. Goldman Sachs analyst Makoto Kuroda recently raised profit forecasts for the 2028 financial year for MUFG, SMFG, and Mizuho, citing higher rates, stronger yields, and a weaker yen. Net profit estimates were lifted by 20%, 11%, and 21% respectively.

For Japan’s largest banks, the renewed interest in JGBs reflects a calculated trade-off. While unrealized losses remain a near-term headwind, management teams appear increasingly focused on the longer-term income potential of higher-yielding government bonds. If yields stabilize and policy tightening progresses gradually, JGBs may once again become a core pillar of megabank balance sheets, supporting earnings momentum in the years ahead.

Source: TradingView

To stay updated on all economic events of today, please check out our Economic calendar

News, historical chart data, and fundamental company data are provided by FastBull Ltd.

Risk Warnings and Disclaimers

You understand and acknowledge that there is a high degree of risk involved in trading. Following any strategies or investment methods may lead to potential losses. The content on the site is provided by our contributors and analysts for information purposes only. You are solely responsible for determining whether any trading assets, securities, strategy, or any other product is suitable for investing based on your own investment objectives and financial situation.