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By Kevin Buckland and Ankur Banerjee
SINGAPORE/TOKYO (Reuters) - Japan's government bond market has turned into a cat-and-mouse arena for investors and the Bank of Japan, as the latter tries to slow a rise in yields towards its new policy ceiling and hungry investors go a step ahead and snap up the bonds.
The game began after the Bank of Japan (BOJ) tweaked its complex seven-year old yield-curve-control (YCC) policy on Friday, saying yields on the 10-year Japanese government bond (JGB) it targets can move flexibly and as far as 1%, rather than be capped at 0.5%.
Over the two trading days since, the market has tried to second-guess the pace at which the BOJ wants yields to move, while the BOJ has run special bond-buying operations to cap yields.
Analysts say the BOJ's small shift in policy has opened investor floodgates to the world's third-biggest bond market, and their pent-up demand could ironically ensure the ceiling on yields is not tested for a long time.
"It's basically happy news for us. And now we've started buying little by little," said a Japanese private pension fund manager, who requested anonymity as he is not authorized to speak to media.
"There is only a very, very small possibility of a sudden or very steep rise in JGB yields, because too many people want to buy the bonds. There are many potential buyers and very few potential sellers in the market."
Tuesday's auction of the benchmark 10-year bonds was proof of such demand. The maximum yield investors demanded was 0.6%, just 10 basis points (bps) above the previous policy cap.
The foreign bid for JGBs has been strong this year as rising rates in the United States and Europe meant dollar and euro investors get paid a lot for hedging their yen holdings.
Local banks, pension funds and insurance companies are now joining that bid for JGBs, hoping the still negative overnight rates, a slightly steeper yield curve and reduced BOJ presence in the bond market will allow for more returns and liquidity.
"The initial target for investors seems at least 0.70% to 0.80% so we continue to expect a grind higher in yields and are positioned for such," said Ales Koutny, head of international rates at Vanguard Asset Management.
"That's the kind of level we heard over and over again from local investors. It also starts looking interesting on a risk reward for currency-hedged investors."
JGB HOLDINGS
Latest surveys show most Japanese insurance firms (lifers) brought money back home into yen this year, but kept it idle rather than put it in loss-making JGB investments.