(Jan 21): A sharp rise in volatility in Japan’s government bond (JGB) market could spill over into other markets — especially US Treasuries — forcing some investors to cut back risk across portfolios, Citigroup Inc said.
Risk parity funds, which allocate capital across multiple asset classes from stocks to bonds and commodities with equal volatility, may need to sell as much as one third of their current exposure, potentially triggering up to US$130 billion ($166.93 billion) of bond selling in the US alone, Mohammed Apabhai, head of Asia trading strategy at Citigroup Global Markets, wrote in a note to clients on Tuesday.
Japanese Prime Minister Sanae Takaichi’s election pledge to cut food taxes has triggered a surge in long-end yields, with 30- and 40-year bond yields jumping more than 25 basis points to fresh highs on Tuesday. With a snap election in Japan coming on Feb 8, investors are worried there will be more volatility ahead. A gauge of JGB liquidity deteriorated to record levels on Tuesday, underscoring what many see as a buyers’ strike.
Longer maturity JGBs rebounded on Wednesday after Finance Minister Satsuki Katayama called for calm among market participants, while US Treasury Secretary Scott Bessent said he had spoken with Katayama and that the moves had impacted Treasuries.
The South Korean bond market is also significantly vulnerable to rising JGB volatility, Apabhai said in the note. Since the start of July 2024, foreign buyers of KTBs have now lost more than 10% in aggregate, raising the risk of stop-loss selling. UK gilts may also be vulnerable, he added.
Volatility in Japan’s once-slumbering bond market has been picking up since early last year amid growing fiscal concerns, with meaningful spillover impact globally. The shift followed the Bank of Japan’s decision to scrap its yield-curve control regime and begin scaling back JGB purchases.
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Analysts now see Japan as a major exporter of global bond volatility, with surging super-long yields amplifying market ructions already fuelled by fears over widening fiscal deficits worldwide. Goldman Sachs Group Inc strategists have estimated that for every 10 basis point “idiosyncratic JGB shock,” investors can expect around two to three basis points of upward pressure on US, German and UK yields.
The US debt market has long been exposed to risks from Tokyo, given that Japanese investors are the largest foreign holders of US bonds. Treasuries have become steadily more susceptible to changes in JGBs since 2022, when the BOJ started to loosen its grip on bond yields, according to Bloomberg’s analysis.
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