October 03, 2016
Economics Group
Special Commentary
Jay H. Bryson, Global Economist
[email protected] ● (704) 410-3274
Who Gets Hurt If JGB Yields Spike?
Executive Summary
The Bank of Japan (BoJ) recently announced a change in its monetary policy that it hopes will
lead to a sustained rise in the CPI inflation rate in Japan. We are skeptical that the BoJ will
actually succeed. However, a sustained rise in the CPI inflation rate would cause yields on
Japanese government bonds (JGBs) to rise significantly, which would lead to financial losses for
owners of those bonds. Who would get hurt if JGB yields spike?
Japanese financial institutions own the lion’s share of JGBs, so the majority of the losses would
accrue to those institutions. Foreigners would not be immune, but their losses should be
manageable due to their relatively low exposure to JGBs. The indirect effect on foreigners should
be manageable as well. Although Japanese financial institutions could sell foreign securities to
offset losses on their JGB holdings, their holdings of foreign securities are not so extensive to
cause a complete meltdown in foreign financial markets. Any upward movement in JGB yields
could lead to some volatility in other financial markets, but it likely would not produce a
generalized global financial crisis.
What Happens If the BoJ Actually Succeeds in Raising Inflation?
As we describe in more detail in a recent report, the BoJ recently made two changes to its
monetary policy stance.1 First, the central bank will no longer target an annual increase in the
monetary base of ¥80 trillion. Rather, the BoJ will now purchase government bonds “so that
10-year JGB yields will remain more or less at the current level (around zero percent). In
addition, the BoJ now pledges to continue purchasing bonds until the CPI inflation rate “exceeds
the price stability target of 2 percent and stays above the target in a stable manner.” Previously,
the BoJ had pledged to only return inflation to the 2 percent target.
The BoJ has tried on many occasions over the past two decades to generate a positive rate of
inflation, but it has largely been unsuccessful (Figure 1). So some skepticism is warranted that
“this time is different” and that the central bank will actually succeed in returning inflation to
2 percent or higher. Moreover, some analysts have been warning for years that a sharp upward
movement in government bond yields in Japan is imminent. However, the downward trend in
Japanese bond yields over the past two decades shows that those warnings have been premature.
Indeed, the yield on the 10-year JGB slipped into negative territory earlier this year (Figure 2).
But maybe this time really is different. Maybe the BoJ really will be able to lift the CPI inflation
rate in Japan on a sustained basis. If so, then JGB yields likely would rise as higher inflationary
expectations take hold. If this increase in yields—equivalently a decline in bond prices—is
significant, then holders of JGBs could experience meaningful financial losses on a mark-tomarket basis. Although we are not predicting a sharp rise in JGB yields anytime soon, it may be
instructive to consider who potentially could suffer significant losses on their JGB portfolio in the
event that the unlikely actually does occur.
1
See “BoJ Targets 10-Year Yield & Pledges to Overshoot on Inflation” (September 21, 2016). Also
available upon request.
This report is available on wellsfargo.com/economics and on Bloomberg WFRE.
The BoJ hopes to
raise inflation to
above 2 percent.
Who Gets Hurt If JGB Yields Spike?
October 03, 2016
WELLS FARGO SECURITIES
ECONOMICS GROUP
Figure 1
Figure 2
Japanese Consumer Price Index
10-Year Japanese Government Bond
Year-over-Year Percent Change
Yield
5%
5%
4%
4%
3%
3%
2%
2%
1%
1%
0%
0%
-1%
-1%
-2%
9%
-2%
CPI: Aug @ -0.5%
-3%
-3%
90
92
94
96
98
00
02
04
06
08
10
12
14
9%
10-Yr Government: Sep @ -0.09%
8%
7%
7%
6%
6%
5%
5%
4%
4%
3%
3%
2%
2%
1%
1%
0%
0%
-1%
16
8%
-1%
90
92
94
96
98
00
02
04
06
08
10
12
14
16
Source: IHS Global Insight and Wells Fargo Securities
Japanese Financial Sector Has Largest Exposure to JGBs
As shown in Figure 3, the outstanding debt of the central government in Tokyo tripled between
1998 and 2016 and currently stands near ¥1 quadrillion (about $10 trillion at the current
USD/JPY exchange rate). Today, the JGB market is the world’s second largest government bond
market.
Japanese
financial
institutions own
the majority of
JGBs.
Figure 4 shows the ownership composition of those bonds. Historically, the BoJ owned 10 percent
to 20 percent of the outstanding JGBs, but that percentage has risen to nearly 40 percent today
(more than ¥360 trillion) due to the Quantitative and Qualitative Monetary Easing program
(QQE) that the central bank has undertaken in recent years. The majority of the outstanding
JGBs—nearly ¥525 trillion—is held by domestic financial institutions (i.e., Japanese banks,
insurance companies, pension funds), and these institutions would suffer the most if yields on
JGBs were to shoot higher. Foreigners hold 11 percent (about ¥110 trillion or roughly $1 trillion at
current exchange rates) while the direct holding of the domestic non-financial sector (households
and non-financial businesses) accounts for only 2 percent of the outstanding amount of JGBs. We
will return later to discuss the domestic financial sector in more detail, but we turn our attention
now to the foreign owners of JGBs.
Figure 3
Figure 4
Japanese Government Debt
Ownership Structure of Japanese Government Debt
As a Percentage of Total
Trillions of Yen
¥1,000
¥900
¥1,000
Japanese Government Debt: Q1 2016 @ ¥966.7 T
100%
Domestic Financial Sector
¥900
90%
¥800
¥800
80%
¥700
¥700
70%
¥600
¥600
60%
60%
¥500
¥500
50%
50%
¥400
¥400
40%
40%
¥300
¥300
30%
30%
¥200
¥200
20%
20%
¥100
¥100
10%
10%
¥0
1998
2000
2002
2004
2006
2008
2010
2012
2014
Source: CEIC and Wells Fargo Securities
2
100%
¥0
2016
0%
1998
90%
Rest of World
80%
Domestic Non-Financial Sector
Bank of Japan
2000
2002
70%
2004
2006
2008
2010
2012
2014
0%
2016
Who Gets Hurt If JGB Yields Spike?
October 03, 2016
WELLS FARGO SECURITIES, LLC
ECONOMICS GROUP
Which Foreign Countries Have Exposure to JGBs?
As noted above, foreigners own more than ¥100 trillion ($1 trillion) worth of JGBs.
Unfortunately, the data that would tell us exactly who owns those securities are not readily
available. However, data from the Bank for International Settlements (BIS), which concentrates
solely on banks (as distinct from other financial institutions such as insurance companies,
pension funds, etc.) are instructive. The BIS data show that foreign banks had $377 billion worth
of aggregate exposure to the Japanese “official” sector at the end of Q1-2016.2 The Japanese
government has few loan liabilities, so the vast majority of this exposure by foreign banks would
take the form of JGB holdings. So who owns the other $600 billion or so of the remaining JGBs
that we know foreigners hold?
Holdings of
JGBs by foreign
central banks
total $377
billion.
Foreign central banks own a good chunk of it. The Japanese yen is one of the world’s reserve
currencies, so central banks in most countries own JGBs. Using data from the International
Monetary Fund and some simplifying assumptions, we estimate that about $400 billion worth of
JGBs may be held in the form of foreign exchange (FX) reserves at the world’s central banks. The
remaining $200 billion or so would be owned by non-bank financial institutions (e.g., insurance
companies, pension funds, mutual funds) in foreign economies.
As noted above, foreign banks have $377 billion worth of exposure to the Japanese official sector,
and the countries with the most absolute exposure include the United States, France and the
United Kingdom (Figure 5). If we assume that the non-bank financial sector in foreign economies
has exposure to JGBs in the same proportion as foreign banks, then we can derive estimates of
total exposure to JGBs by country. As shown in Figure 5, the United States financial sector could
have $200 billion worth of exposure to JGBs, followed by France (about $150 billion) and the
United Kingdom (more than $100 billion).
These estimates of JGB holdings per country are clearly sizeable. But to put these estimates into
perspective, consider that the assets of the U.S. financial sector total $86 trillion. The British
financial system has about $28 trillion worth of assets while the comparable figure in France is
roughly $15 trillion. In other words, the JGB holdings of the United States, France and the United
Kingdom are miniscule when placed in the context of the size of the financial system in those
economies. In short, a sharp decline in JGB prices is not likely to bring the financial systems of
large non-Japanese economies directly to their knees.
Financial
systems of large
non-Japanese
economies likely
would not be
brought to their
knees.
Figure 5
Foreign Exposure to JGBs
In Billions of Dollars; Q1-2016
$250B
$250B
Foreign Banks
Estimated Total Exposure
$200B
$200B
$150B
$150B
$100B
$100B
$50B
$50B
$0B
$0B
US
FR
GB
AU
GE
CA
Source: Bank for International Settlements and Wells Fargo Securities
2
The official sector includes the central government in Tokyo, government agencies and provincial and
municipal governments.
3
Who Gets Hurt If JGB Yields Spike?
October 03, 2016
WELLS FARGO SECURITIES
ECONOMICS GROUP
Could Japan Cause a Generalized Asset Price Rout?
But could there be an indirect effect from a potential rout in the JGB market that could be more
problematic for financial markets outside of Japan? Japanese financial institutions, which we
know have sizeable holdings of JGBs, could also have meaningful exposure to foreign securities. If
these Japanese financial institutions were to suffer significant losses on their JGB holdings, then
they could potentially sell some of their foreign securities in an attempt to offset some of these
losses. Could this offloading of foreign securities by Japanese financial institutions lead to a
generalized decline in asset prices worldwide, which then would cause meaningful losses for
foreign financial institutions?
Figure 6
Figure 7
Foreign Claims of Japanese Banks
Japanese Bank Exposure
Billions of Dollars
Foreign Security Holdings of Japanese Financial Institutions
¥400T
¥400T
$1600B
$1600B
Q1-2016
Total Japanese Bank Exposure: Q1 2016 @ ¥367.9T
¥350T
¥350T
$1400B
$1400B
¥300T
¥300T
$1200B
$1200B
¥250T
¥250T
$1000B
$1000B
¥200T
¥200T
$800B
$800B
¥150T
¥150T
$600B
$600B
¥100T
¥100T
$400B
$400B
¥50T
$200B
$200B
¥50T
¥0T
1998
2000
2002
2004
2006
2008
2010
2012
2014
¥0T
2016
$0B
$0B
US
CI
UK
FR
GE
AU
LU
NL
TH
HK
Source: CEIC, Bank for International Settlements and Wells Fargo Securities
Japanese
financial
institutions have
sizeable
holdings of
foreign
securities.
Figure 6 shows that the holdings of foreign securities by Japanese financial institutions are indeed
sizeable. Since 1998 these holdings have tripled and they currently total more than ¥350 trillion
(about $3.5 trillion at current exchange rates). So which countries would be most at risk from a
potential fire sale of securities by Japanese financial institutions?
We do not have a precise country breakdown of the foreign securities that Japanese financial
institutions own in aggregate. However, BIS data on the foreign claims of Japanese banks offer
some clues. The United States is the preferred foreign destination for Japanese banks, accounting
for more than 40 percent (nearly $1.6 trillion) of the total claims that the Japanese banking
system has on foreign economies (Figure 7). If we ignore the Cayman Islands (CI), the United
Kingdom and France are distant runner-ups to the United States at roughly $185 billion each.3
Furthermore, it appears that holdings of debt securities account for the majority of Japanese bank
claims on foreign economies.
Could Japanese selling of those securities put upward pressure on bond yields in foreign
economies, especially on yields on U.S. Treasury securities? Figure 8 shows the 60-month rolling
correlation coefficient between the yield on the 10-year JGB and the yield on the 10-year U.S.
Treasury security. Between 2000 and 2013, the correlation coefficient between these two yields
was high. Starting in 2013, however, the coefficient nosedived and it stands at only 0.20 today. At
face value, the low degree of correlation between these two yields today would suggest that a
sharp rise in JGB yields would have little effect on yields on U.S. Treasury securities.
That said, the swoon in the correlation coefficient coincided with a divergence in the respective
policy stances of the Federal Reserve and the BoJ. In mid-2013 Federal Reserve Chairman
Bernanke indicated that the Fed would eventually “taper” its purchases of U.S. Treasury and
mortgage-backed securities, a process that began in January 2014. Around the same time, the BoJ
3
The sizeable claims that Japanese banks reportedly have on the Cayman Islands likely reflects the
foreign securities that financial institutions in the Cayman Islands hold on a custodial basis for their
Japanese clients.
4
Who Gets Hurt If JGB Yields Spike?
October 03, 2016
WELLS FARGO SECURITIES, LLC
ECONOMICS GROUP
ramped up its purchases of Japanese securities. If a rise in Japanese CPI inflation leads the BoJ to
purchase fewer JGBs, if not stop purchasing altogether, then the correlation between JGB yields
and yields on U.S. Treasury securities would presumably move higher again. In other words, a
jump in JGB yields could conceivably put upward pressure on long-term interest rates in the
United States.
Figure 9
Figure 8
Correlation Coefficient
Japanese Ownership of US Treasury Securities
As Percent of Total
10-Year JGB vs 10-Year US Treasury
1.00
0.90
1.00
Correlation Coeffecient: Aug @ 0.2
0.80
0.70
0.70
0.60
0.60
0.50
0.50
0.40
0.40
0.30
0.30
0.20
0.20
0.10
0.10
0.00
2002
2004
2006
2008
2010
2012
2014
2016
20%
Japanese Ownership: Jun @ 8.2%
0.90
0.80
0.00
2000
20%
15%
15%
10%
10%
5%
0%
2002
5%
0%
2004
2006
2008
2010
2012
2014
2016
Source: Bloomberg LP, IHS Global Insight and Wells Fargo Securities
How many Treasury securities could potentially be offloaded by Japan, and how much upward
pressure would it put on U.S. bond yields? Data from the U.S. Treasury Department show that
Japanese holdings of U.S. government bonds currently total about $1.2 trillion, which clearly is a
meaningful number. However, the absolute size of Japan’s holdings should be put into the context
of the total amount of U.S. Treasury securities outstanding. As shown in Figure 9, Japan’s share of
the publicly traded debt of the U.S. government has trended down from 16 percent about a decade
ago to 8 percent today.
Japan owns
only 8 percent of
the marketable
Treasury debt.
Furthermore, the aggregate $1.2 trillion figure for Japan includes the holdings of both the BoJ in
the form of FX reserves as well as ownership by private Japanese investors. Although data on the
precise amount of Treasury securities held by the BoJ is not publicly available, back-of-theenvelope estimation indicates that BoJ holdings of U.S. Treasury securities are likely to total
roughly $700 billion or so.4 The remaining $500 billion would be owned by private Japanese
investors.
The BoJ likely would not sell a significant amount of its FX reserves, let alone dump them en
masse. What would happen in the unlikely event that Japanese investors unloaded all of their
$500 billion worth of U.S. government bonds? Yields on those securities clearly would move
higher. But a complete meltdown in the market for U.S. Treasury securities likely would not
happen because private Japanese investors account for only 4 percent of the publically tradeable
stock of U.S. Treasury securities. In short, the indirect effects of a sharp rise in JGB yields should
be manageable.
Conclusion
In our view, Japanese inflation will remain dormant and JGB yields will remain depressed for the
foreseeable future.5 However, if inflation in Japan were to shoot up significantly, then JGB prices
4
The value of the BoJ’s FX reserves currently totals about $1.2 trillion. If U.S. dollars account for roughly
60 percent of the BoJ’s FX reserves, which is the average percentage for central banks in advanced
economies, then the BoJ holdings of U.S. Treasury securities would total roughly $700 billion.
5 We forecast that the Japanese CPI inflation rate in 2018 will be only 0.5 percent, and that the yield on
the 10-year JGB in Q1-2018 (end of our forecast) will be less than 0.10 percent. See our Monthly
Economic Outlook, which is posted on our website.
5
Who Gets Hurt If JGB Yields Spike?
October 03, 2016
WELLS FARGO SECURITIES
ECONOMICS GROUP
could nosedive and, conversely, yields would spike. In that event, Japanese financial institutions,
which own the lion’s share of the outstanding stock of JGBs, could suffer meaningful mark-tomarket losses. Foreigners, who in the aggregate own about $1 trillion worth of JGBs, would not be
immune to the mark-to-market effects of lower JGB prices. However, foreign central banks
account for almost half of the foreign ownership of JGBs. Therefore, any financial losses suffered
directly by foreign financial institutions from lower JGB prices should be manageable.
Any indirect effects should be manageable as well. Japanese financial institutions may sell some
of their holding of foreign securities, which appear to be largely held in the United States, to offset
losses on JGBs. Although Japanese selling of U.S. securities undoubtedly would put upward
pressure on long-term U.S. interest rates, an outright freefall in the U.S. bond market likely would
not transpire. Private Japanese investors own only 4 percent or so of the outstanding stock of U.S.
Treasury securities.
We are not trying to suggest that a sharp rise in JGB yields would be a non-event. Fed Chairman
Bernanke indicated in May 2013 that the Fed would eventually “taper” its QE program, an
acknowledgement that led to a 140 bps rise in the yield on the 10-year Treasury security in the
subsequent 4 months. Bond yields in most other countries followed Treasury yields higher during
that period. But the “taper tantrum” was hardly a replay of the global financial crisis of 2008.
Similarly, any upward movement in JGB yields could lead to some volatility in other financial
markets, but it likely would not produce a generalized global financial crisis.
6
Wells Fargo Securities Economics Group
Diane Schumaker-Krieg
Global Head of Research,
Economics & Strategy
(704) 410-1801
(212) 214-5070
[email protected]
John E. Silvia, Ph.D.
Chief Economist
(704) 410-3275
[email protected]
Mark Vitner
Senior Economist
(704) 410-3277
[email protected]
Jay H. Bryson, Ph.D.
Global Economist
(704) 410-3274
[email protected]
Sam Bullard
Senior Economist
(704) 410-3280
[email protected]
Nick Bennenbroek
Currency Strategist
(212) 214-5636
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Anika R. Khan
Senior Economist
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Eugenio J. Alemán, Ph.D.
Senior Economist
(704) 410-3273
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Azhar Iqbal
Econometrician
(704) 410-3270
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Tim Quinlan
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