GPIF tremors in the JGB market?
For the second time in just a few days, trading in the JGB market was halted on monday the 13th of May. The downward move triggered circuit-breakers on the exchange and all trading was stopped. This is not a decision made by an individual, but rather an automatic mechanism that kicks in if the price of JGB’s moves ‘too rapidly’, but either way, it indicates severe stress in the system.
The benchmark 10-year bond futures fell 0.75 point to 142.95, and at one point traded as low as 142.65, which was the lowest level in a year. The 10-year cash bond yield rose to as high as 0.80%, its highest level since February. Since the BoJ announced it’s latest QE attempt on April 4th, the 10-year yield has now more than doubled.
The following charts (courtesy of Zerohedge),demonstrate the two halted trading events.
The 5 year yield also spiked.
There are unsurprisingly plenty of opinions about the causes of this phenomenon. There is speculation that large domestic holders of JGB’s are beginning to shift money away from JGB’s and into the stock market, in anticipation of a rise as a result of Abenomics. The chart below shows how Japanese funds have flowed into European bond markets during the past week in search of yield:
This would fit with the observation that the biggest investors are typically the last to the party, and often enter markets at the very peak, and exit at the very trough. It is also consistent with the fact that funds are now flowing out of Japan in search of yield – hence at least partly the pressure on the Yen – and it is obvious that a large portion of this will originate in the JGB market.
Approximately two years ago the GPIF (Government Pension Investment Fund – the largest pension fund in the world worth $1.2trn), announced that it was reaching a point where, due to demographics, it now was becoming a net seller of JGB’s, and also that it was setting up a new lending facility in order to avoid selling JGBs. In itself a remarkable decision for a pension fund to make.
(For more on the changing demographics and their effect on public finances, please see this piece: https://nipponmarketblog.wordpress.com/2013/04/25/japan-is-insolvent-but-please-dont-worry/)
If this pattern of behavior has changed and the GPIF is now indeed a net seller of JGB’s, we would have to expect noticeable pressure on JGBs. This step would be a logical one for the GPIF in an environment where interest rates are clearly heading higher, as this would push up the costs incurred by the GPIF when borrowing funds to finance its pension payouts.
In February of this year, the Chairman of the GPIF Takahiro Mitani stated that the fund would review its long-term investment target and portfolio allocation model “around April”.
It is worth keeping in mind that the GPIF holds around 10% in domestic stocks, so the rally in stocks since late last year must have proven a boon for the fund. However, the holding of domestic bonds is around 2/3 of the entire fund, so any fall in JGB’s will obviously hurt the fund, which has what appears to be a somewhat optimistic return target of 3.2%. Precisely how these ‘swings and roundabouts’ have turned out on a net basis is anyone’s guess, but either way NipponMarketBlog believes this review has most likely resulted in a reduction in the domestic bond allocation going forward.
At any rate, it is worth noting that the move in JGB’s happened on the monday after the Wall Street Journal published an article during the weekend by Jon Hilsenrath (who rather perversely seems to have become the official mouthpiece for the Federal Reserve), hinting that the Fed is nearing the end of the road as far as continued QE is concerned. This led to another large move in the Dollar/Yen exchange rate, and this can obviously have a significant impact on both stocks and bonds.
This level of JGB market volatility does not necessarily mean that the JGB market faces imminent collapse, and that this is now the end of the road for Prime Minister Abe and BoJ Governor Kuroda’s massive monetary stimulus experiment. It does, however, point to significant unease in the market about the tenability of the position that the Japanese authorities are taking, namely that huge expansion of monetary policy will result in manageable inflation, which will stimulate consumer and investor behavior, which in turn will propel the economy back onto a sustainable growth track. It all sounds deceptively simple, but one has to question why it has not worked for the past decade, and also why a similar approach has failed in the US and in Euroland as well.
Seemingly unphased, Governor Kurado stated the following at the recent G7 meeting (where again, there was no criticism of Japanese monetary policy):
“I do not expect a sudden spike in long-term bond yields. In the long-run, if the economy recovers and inflation heads towards two percent, we might see nominal interest rates rise but that’s natural.”
Note that when talking about economic recovery, Kuroda used the word “if” as opposed to the word “when”. Could it be that the lack of conviction regarding the impact of QE and the ability to control its effects in the medium term that we at NipponMarketBlog feel, is perhaps shared by the BoJ itself?
Time will tell whether this is just a short term flutter in the market, or if Mr Abe and Mr Kuroda already got more than they bargained for when they decided to attempt to reflate the economy.
=== UPDATE (14th of May 2013) ===
Today’s trading session included another jump in rates, and a close call vis-a-vis the JGB market circuit breaker:
We are guessing the BoJ is in the market trying to force rates back down again, lest the idea that things could be on the way to getting our of hand takes hold.
=== UPDATE (15th of May 2013) ===
Yet again today the futures market was a volatile place, and trading was close to the circuit breakers 3 times.
The yield on the 10-year cash bonds rose 4.5 basis point to 0.900%, having touched 0.920%, its highest level in over a year, during the trading session. The five-year bond yield rose to 0.455%.