(CORRECTS total liquidity amount in graf 4)
By Helen Bartholomew
LONDON, May 24 (IFR) – Extreme volatility in the Japanese
government bond market could trigger a sell-off on a par with
what happened throughout the third quarter of 2003, when local
banks and foreign investors were forced to dump their JGB
holdings after heightened volatility caused the assets to exceed
internal value-at-risk (VaR) limits.
According to analysts at JP Morgan, the threat of a
so-called “VaR shock” highlights one of the unintended
consequences of quantitative easing, and the situation could be
exacerbated this time around.
“The proliferation of risk parity investors and funds, which
are strict value-at-risk investors and are heavily invested in
bonds currently, is likely raising the sensitivity of bond
markets to self-reinforced volatility-induced selling,” said
Nikolaos Panigirtzoglou, head of flows and liquidity for Europe
at JP Morgan, in a report.
Last month, Japan’s central bank confirmed plans for a
liquidity injection of at least 120 trillion yen (US$1.19trn)
that is intended to boost inflation to 2% over the next two
years. The result has been a surge in JGB volatility and rising
yields on anticipation of widespread shift from fixed-income to
equities.
“It’s an example of the pro-cyclicality of markets. Those
with mechanical VaR-based limits will increase positions as vol
reduces, and cut positions as vol increases, just like in 2003,”
said Guillaume Amblard, global head of fixed-income trading at
BNP Paribas.
“It creates a snowball effect and it’s exacerbated by the
fact that there are some big leveraged positions in JGBs.”
JP Morgan analysts note that 60-day standard deviation of
the daily changes in 10-year JGB yields has doubled to 4bp since
the BoJ confirmed its monetary easing strategy on April 4 – the
highest level since 2008.
Those levels remain some way from where the 2003 sell-off
was triggered. At that time, 60-day standard deviation jumped
from 2bp to more than 7bp between June and September as 10-year
yields tripled from 0.56% to 1.58%.
However, the strength of the current equity bull market and
corresponding pressure on JGBs could drive large shifts
relatively quickly. Since the liquidity injection was confirmed
in early April, 10-year yields jumped from 0.5% to hit a
one-year high of 0.895% last Wednesday.
“We think that hitting 1% on the 10-year JGB will prove to
be an important psychological level. There’s still some way to
go, but we wouldn’t be surprised to [see a] test very soon. It’s
a very strong bear market that we’re seeing,” said Mathieu
Gaveau, global head of IR options, solution and inflation
trading at BNP Paribas.
SAFETY NET
Whether the situation now is directly comparable to 2003 is
a matter of debate, especially bearing in mind the safety net
provided by central bank intervention.
“It’s difficult to see a rout in JGBs when you’ve got the
biggest buyer in the world supporting the market,” said a rates
trader at one European house.
The potential for a 2003-style catastrophe is also reduced
because bank investors have had some time to prepare.
“It’s less likely to happen purely because everyone is
talking about it. We’ve already seen the equivalent in JGBs of
Treasuries selling off by circa 100bp and no one is calling it a
full blow-up,” said Richard Jackson, head of flow rates trading
for Europe at Deutsche Bank.
“Everyone has had some time to adjust to the new volatile
environment, and many have addressed their VaR issues and
already stopped out where they needed to.”
JP Morgan’s Panigirtzoglou believes that regional and
co-operative (or shinkin) banks are the most vulnerable to rate
increases as the maturity mismatch between assets and
liabilities is currently running at all-time highs for such
entities. Analysis shows that a 100bp yield curve shift results
in a loss of seven trillion yen for regionals and co-operatives
combined, which equates to 35% of Tier 1 capital.
(Reporting by Helen Bartholomew; Editing by Matthew Davies)
