(Bloomberg) -- Investors are bracing for further increases in yields and volatility in Japan’s sovereign bond market as central bank officials consider reducing their massive debt holdings.

The Bank of Japan bought only ¥4.5 trillion ($29 billion) of government bonds last month, the lowest amount since March 2013, data released last week showed. A majority of BOJ watchers forecast that the monetary authority will decide on June 14 to cut the amount of sovereign notes it buys, while people familiar with the matter have said such a shift is being considered. 

Benchmark 10-year yields have been on a roller-coaster ride, surging to as high as 1.1% last month, a level unseen since 2011, only to give up about half of the gain. The spread between overnight-indexed swaps used for hedging and 10-year notes has narrowed to the least since 2022, reflecting concern about reduced BOJ debt buying. Implied volatility on debt futures has climbed above this year’s average.

“With the current volatile market, the BOJ is unlikely to give a strong forward guidance so that they can keep policy flexibility,” said Shoki Omori, chief desk strategist at Mizuho Securities Co. in Tokyo. “Investors will continue to expect further bond-buying cuts in the future, putting upward pressure on yields.”

The BOJ has accumulated more than a half of the nation’s government debt mainly as a result of its two decades of quantitative easing. The persistent weakness in the yen is adding pressure on the central bank to lift interest rates, a move that would likely help support the Japanese currency.

The economist survey showed though that many analysts are revising their forecasts for when the BOJ will hike rates to further in the future. That comes at a time when the European Central Bank cut rates and its peers are also considering doing so. 

Japan’s radical easy-money experiment has weakened many of the mechanisms that help investors price and trade bonds. That’s because there was less need for them at a time when authorities were pumping cash into the market. 

Many Japan debt investors still feel that the bond market isn’t working properly in areas like pricing debt and having enough volume, a BOJ survey showed. But the main gauge for the market’s functioning has been improving since May 2023 as the BOJ dismantled its yield-curve-control and negative-interest-rate policy. 

That has spurred investor speculation the central bank will seek to further cut bond buying to help shore up the health of the nation’s debt market.

Swings in debt prices are becoming more severe as the BOJ weighs further policy changes. This is highlighted in the 4.06% implied volatility for 10-year bond futures on Friday, higher than this year’s average of 3.60%.

The BOJ cut back on bond buying at one of its regular operations for the first time this year on May 13. Though the bank still kept purchases within its planned range and hasn’t reduced buying at other recent operations, the move fueled speculation that the BOJ may officially decrease monthly purchases from the current ¥6 trillion. Monthly bond buying has already slowed sharply from a record ¥23.7 trillion hit in January 2023. 

“If they change the amount now and heighten volatility, it will be difficult for the bank to raise interest rates to normalize policy,” said Takashi Fujiwara, chief fund manager at the fixed-income department at Resona Asset Management Co.  

Currency market players appear to be paying attention to changes in the amount of bond purchases while rates market players are closely watching which maturity bonds will see reduced buying, said Hideo Shimomura, senior portfolio manager at Fivestar Asset Management Co. “A decrease in the buying of long-end securities will put further upward pressure on their yields,” he said.

Here are key Asian economic data this week:

  • Monday, June 10: Japan 1Q final GDP and BoP current account balance, Malaysia industrial production
  • Tuesday, June 11: Australia business confidence, Philippines trade balance
  • Wednesday, June 12: Bank of Thailand interest rate decision, China CPI and PPI, India CPI and industrial production, Japan PPI
  • Thursday, June 13: Australia employment change, CBC interest rate decision
  • Friday, June 14: BOJ interest rate decision, New Zealand manufacturing PMI and house sales

--With assistance from Hidenori Yamanaka and David Finnerty.

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