Global fund managers are once again pulling money from Japan's bond market, just over a year after yields finally rose enough to attract their return.

Institutions including T. Rowe Price Group Inc., Schroders, and Brandywine Global Investment Management have recently cut their exposure to Japanese long-term government bonds or maintain only tactical positions. The latest April data shows overseas investors were net sellers of Japanese super-long-term bonds for the first time in 2024, meaning sales exceeded purchases.

Even with widespread market expectations for a Bank of Japan rate hike on Tuesday, investors remain concerned that it is unlikely to tighten monetary policy swiftly enough to curb inflation and stabilize markets. For many, the allure of yields reaching multi-decade highs this year is being overshadowed by worries over the central bank's slow policy response and its susceptibility to political pressure.

Brandywine Global Investment Management portfolio manager and senior research analyst Carol Lye stated, "Given Japan's current environment of negative real interest rates, we believe the Bank of Japan is somewhat behind the curve in its policy." She noted the firm has recently reduced its Japanese government bond exposure and sold its 30-year bond holdings, reallocating some funds into UK gilts. She added that while Japanese bond valuations have improved, "the structural supply and demand dynamics remain complex."

This shift in investor sentiment presents a challenge for Japanese policymakers. Higher yields were hoped to attract foreign capital back to Japan's bond market after years of ultra-loose monetary policy. However, many investors now say the biggest obstacle to holding Japanese super-long-term bonds is not valuation but a crisis of confidence. The timing of this investor hesitation is delicate, as the Bank of Japan gradually reduces its market intervention while traditional domestic buyers have yet to return in force.

T. Rowe Price portfolio manager Vincent Chung bought Japanese government bonds in January, having been underweight the asset class for the past year. However, a month later, he reduced his holdings again as fiscal concerns intensified. He stated, "This trade does face some headwinds, such as expanding fiscal spending, changing long-term demand, and the Bank of Japan's continued balance sheet reduction."

For many investors, concerns extend beyond the central bank. The expansionary fiscal agenda promoted by Japanese Prime Minister Sanae Takaichi has heightened market anxiety over oil-driven inflation and the pace of policy normalization. The government's supplementary budget and repeated calls for measures to ease rising household living costs have also fueled concerns about a divergence between fiscal and monetary policy directions. Takaichi is seen as a supporter of loose monetary policy.

"If the market perceives the Takaichi administration is pressuring the Bank of Japan, worries about the central bank's slow response could resurface," said Shinichiro Arie, co-head of fixed income at Amundi Japan, who maintains an underweight position on Japanese bonds. He believes that for him to lift that underweight stance, "the key is for the government to stop interfering with monetary policy."