Japan bond yields stifled by BOJ's heavy hand as investors hold out

TOKYO, Sept 5 (Reuters) - The Japanese government bond market has frozen over, as investors hold out for higher yields while an overbearing Bank of Japan bond-buying programme drains supply.

A month-long run of poor auction results, culminating in a weak 10-year sale on Tuesday, point to an unwillingness among buyers to purchase bonds at current levels while the central bank is artificially keeping rates low.

More than a month after the Bank of Japan unexpectedly tweaked its yield curve control (YCC) to double the cap on the 10-year yield to 1%, it has been mired around 0.65%.

That is even as equivalent U.S. Treasury yields, which tend to be the biggest overseas influence on JGB rates, surged to 2007 financial crisis peaks.

"We would love to buy Japanese bonds at the right yield, but as the BOJ shadow continues to stop yields from jumping higher, we continue to be underweight across the board," said Ales Koutny, head of international rates at Vanguard.

"We are at an awkward place regarding BOJ policy: We know they changed YCC, but we don't know how much higher yields they are willing to tolerate," he said. "Markets don't want to fight the BOJ."

The BOJ has been an outlier among global central banks which embarked on their most aggressive tightening campaigns in generations as inflation soared following the pandemic.

Barring recent tweaks to YCC, the BOJ has stubbornly stuck with ultra-stimulative settings, convinced that current inflationary pressures are mostly transitory.

Last week, BOJ Deputy Governor Shinichi Uchida said that he doesn't expect a sharp rise in yields and that the central bank was ready to intervene to curb advances toward 1%, "depending on the speed of the moves."

BOJ board member Naoki Tamura said separately that the new cap was "a protective measure," and he didn't expect the yield to actually rise to that level.

CAPPED BY RINBAN

The recent peak in 10-year yields was 0.675% on Aug. 23, the day after Treasury yields hit a 16-year top.

"A lot of people are waiting for 0.7% or above, so it's very tough to buy a large amount at 0.65%," said a Japanese private pension fund manager, who requested anonymity as he is not authorized to speak to media.

He expects the BOJ will eventually allow yields to rise to 0.7% or 0.8%, possibly as early as October.

However, that depends on a paring down of the central bank's "rinban" purchase operations, which currently hoover up 2.7 trillion yen ($18.37 billion) of 10-year securities per month, the same amount that the Ministry of Finance sells. JGB traders are waiting for a signal on Sept. 29, when the BOJ announces the purchase amounts for the following quarter.

However, while many believe a reduction in the rinban amount is necessary for higher yields, it's not the only view.

Kentaro Hatono, a fund manager at Asset Management One, says that because there is a time lag between when the finance ministry sells the bonds and the four times that the central bank buys them in smaller increments, the reluctance of traders to hold them should force yields up in gradual steps each month, to as high as 0.9% by year end.

"If you want to sell 10-year JGBs before the rinban, you're forced to sell at the market value," Hatono said. And buyers have been demanding higher yields in the secondary market.

At Tuesday's 10-year JGB auction, the yield at the lowest accepted price was 0.668%, far exceeding the current 0.65%.

It extended a sequence of poor auctions that started with a five-year note sale on Aug. 15, followed by a 20-year bond auction that saw the worst demand since 1987.

The finance ministry is due to sell some 900 billion yen of 30-year bonds on Thursday, completing the cycle across tenors.

"The fear is that we're going to have weak auctions for the entire month, and that puts pressure on the BOJ to reduce the rinban amount," said Shoki Omori, chief Japan desk strategist at Mizuho Securities.

"That's going to be key, because the rinban is distorting the supply-demand dynamics," he said. Until then, "I see few investors wanting to go long the 10-year." ($1 = 146.9400 yen) (Reporting by Kevin Buckland; Editing by Vidya Ranganathan and Kim Coghill)