Global fund managers turn collectively! High yields and improved supply-demand dynamics resonate, making Japanese government bonds a hot favorite again.

Global fund managers are once again showing interest in the Japanese bond market, as signs of recovering domestic demand and a more favorable policy environment enhance the appeal of high yields. T. Rowe Price Group Inc., which cut its exposure to Japanese government bonds earlier this year, now favors long-duration bonds. Allianz Global Investors is selectively adding exposure to medium- and long-term bonds, while BNP Paribas Asset Management has established exposure to ultra-long bonds. This shift in attitude contrasts sharply with earlier this year, when even rising yields were not enough to dispel investor concerns: the market worried that the Bank of Japan was raising rates too slowly, fiscal spending was increasing government bond supply, and traditional domestic buyers remained on the sidelines. Now, with the market expecting the BOJ to continue raising rates and insurance institutions re-entering the bond market, fund managers are more confident in seizing current high-yield opportunities. "Our view on JGB duration has become more positive, and we have been selectively adding exposure, particularly in the intermediate-to-long end of the curve," said Mark Tay, chief investment officer for Asia-Pacific fixed income at Allianz Global Investors, which manages 653 billion in assets. "Real yields are more attractive, and we see increasing evidence of domestic demand returning and overseas interest growing, which should help support the market." The shift in tone coincides with a recovery in long-term bonds. The 30-year JGB yield has fallen nearly 40 basis points from its peak of 4.25% earlier this month, despite continued volatility in global bond markets. Since July, the spread between 2-year and 30-year JGB yields has narrowed by about 70 basis points. Japan will hold a two-year government bond auction on Thursday, with demand expected to remain solid. Shoki Omori, chief Japan fixed income strategist at Deutsche Securities, said that with the 10-year yield rising above 3% and the 30-year reaching 4% earlier this yearlevels unseen in decadesvaluations have become increasingly attractive. He estimates that about two-thirds of these yields reflect term premiumthe extra compensation investors demand for holding longer-dated debt. Omori believes that once the prospect of the BOJ's tightening cycle nearing its end becomes clear, that premium could narrow, allowing the long end to outperform other maturities even as rate hikes continue. Buying returns Signs of improving demand are already emerging. Japanese life insurers have been net buyers of ultra-long government bonds for the past four months, with some signaling plans to maintain or increase domestic bond purchases. According to Japan Securities Dealers Association data, overseas investors have also been net buyers of ultra-long JGBs for three consecutive months, reversing net selling in April and June. T. Rowe Price portfolio manager Vincent Chung currently favors the long end, betting on a flattening yield curve amid BOJ rate hikes. This marks a shift from earlier this yearwhen he bought JGBs in January (after being underweight for a year) only to cut exposure a month later due to growing fiscal concerns. Chung now believes that supply and demand will become more balanced by year-end, thanks to recent retail buying and the prospect of additional demand if proposed tax incentives are introduced. Potential changes to the Government Pension Investment Fund's (GPIF) allocation could provide another source of support, though he said any decision would depend partly on global market performance. BNP Paribas Asset Management is also increasing exposure. James McAlevey, head of global aggregate and absolute return, said the firm has increased its long-end JGB position from "very small" earlier this year to "medium-sized," favoring 20-year and 30-year bonds. Fiscal test Fiscal policy remains the biggest obstacle to a further sustained bond market rally, and the fiscal 2027 government bond issuance plan will test the recently revived sentiment. Investors are closely watching how the government will fund food consumption tax cuts and expanded defense spending. T. Rowe Price's Chung said that if the budget plan fails to clarify funding sources, his curve-flattening bet would be at risk. Deutsche Securities' Omori warned that if a larger supplementary budget is introduced, or if the issuance plan fails to further reduce ultra-long bond supply, the recent narrowing of long-bond spreads could reverse. Brandywine Global Investment Management, which cut JGB exposure earlier this year and sold its 30-year holdings, has not yet re-entered. Portfolio manager Carol Lye said the Takaichi cabinet's downplaying of reflation rhetoric has helped stabilize yields, but investors are still waiting for a credible funding plan. With the 10-year yield falling back below 3%, she also sees the possibility of demand slowing. The BOJ will provide another test at its policy meeting on Friday. Officials are widely expected to keep rates unchanged, and investors will focus on Governor Ueda's guidance on the pace of tightening and how far rates are from their ultimate peak. For BNP Paribas's McAlevey, further confidence would require a "relatively restrained fiscal response" from the government and continued BOJ tightening. He said the central bank doesn't necessarily need to hike this week, but a December move and continued "relatively hawkish" communication would suffice.