Borrow short and lend long, with the Bank of England and the Bank of Japan leading the way in abandoning long-term bonds, shifting towards high-frequency rolling "interest rate gambling."

Governments of major global economies are quietly adjusting their debt strategies, increasingly moving away from traditional long-term bonds and embracing shorter-term debt.

Leading this trend are the United Kingdom and Japan. Reports indicate that the UK has reduced its issuance of long-term government bonds to a historic low this year and is considering expanding its ultra-short-term bill market. Meanwhile, after facing a sell-off of long-term bonds, the Japanese government is also responding to market calls by planning to increase the issuance of short-term debt.

Behind this strategic shift is the gradual withdrawal of central banks from years of bond-buying programs, leading to reduced demand for long-term bonds and rising government borrowing costs. Faced with already high debt levels, policymakers are opting to issue lower-yielding but more frequently rolled-over short-term bills, hoping to alleviate fiscal pressure. However, this is akin to betting that future interest rates will decline.

This move is not an isolated case. The United States is increasingly relying on short-term Treasury bills to finance its federal deficit, and countries like Australia have proposed similar policies. The Bloomberg Barclays Global Aggregate Bond Index shows that the average duration of global government bonds has fallen to its lowest level since 2014. Nevertheless, the UK and Japan are undoubtedly the two countries experiencing the most severe decline in long-term bond demand and the most aggressive policy adjustments.

Demand Shift, Traditional Buyers Retreat

The core driving force behind this global shift is the structural change in demand from traditional long-term bond buyers. Central banks reducing their balance sheets have pushed up government financing costs.

In the UK, fixed-income pension plans that have been stable buyers of long-term bonds for decades are now mostly winding down, leading to a significant gap in market demand. Japan faces a similar situation, with Takahiro Otsuka, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities, noting that banks and life insurance companies are no longer as eager to buy ultra-long-term bonds. Additionally, investors are concerned about the economic stimulus plan that Prime Minister Fumio Kishida is preparing to finance through additional budgets, fearing it may create additional pressure on bond supply.

Market dynamics themselves have also made short-term borrowing more attractive. Currently, the yield spread between long-term and short-term bonds is significantly widening. This year, the yield on UK 30-year government bonds reached its highest point since 1998, with its premium over 2-year government bonds rising to the highest level since 2017. In Japan, this spread has also widened to at least its highest level since 2006.

The substantial yield spread makes issuing short-term debt highly attractive in terms of cost. Data shows that bonds with a duration of less than 7 years in the UK are expected to account for 44% of the total new issuance this fiscal year, an increase of nearly 20 percentage points compared to the 2015-16 fiscal year. In Japan, bonds with a duration of 5 years or less are expected to account for about 60% of the total new issuance this fiscal year, up from 56% in fiscal 2015

"Interest Rate Gambling" and Fiscal Sustainability Risks

However, aggressively shortening the duration of debt essentially means the government is betting that long-term bond yields are too high and will fall in the future. The risk of this strategy is that if interest rates do not decline as expected, or even rise, the government will face uncontrollable costs when frequently rolling over debt.

"The risk is that if rates go up, your interest bill will suddenly increase significantly," said Evelyne Gomez-Liechti, an international strategist at Mizuho, in London.

Hiroshi Namioka, chief strategist at T&D Asset Management, also warned:

"If the duration is only two years, it means refinancing must be very frequent. Continuously rolling over short-term loans will raise questions about fiscal sustainability, and we need to be cautious about how this will make future fiscal prospects harder to predict."

Although the U.S. is also increasing the issuance of short-term Treasury bills, its market conditions are significantly different from those of other countries. As of the end of October, short-term Treasury bills accounted for about 22% of the total outstanding U.S. national debt, and according to Citigroup's forecast, this proportion could rise to 26% by the end of 2027.

Unlike the UK and Japan markets, the U.S. has a large and sustained demand for such short-term assets. Over $8 trillion is parked in money market funds, allowing the U.S. Treasury to adjust flexibly according to market demand. U.S. Treasury Secretary Scott Bessent stated last month that his department is "closely monitoring potential long-term changes in demand for specific types of U.S. Treasury securities" and will respond accordingly.

Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, believes this allows the "Treasury to rely more on note issuance, thereby alleviating pressure on long-term yields, as they can postpone plans to increase the size of coupon bond auctions until the end of 2026."

Risk Warning and Disclaimer

Markets are risky, and investments should be made cautiously. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investing based on this is at one's own risk