Tonhe died Silicon Valley Bank failed for many reasons. But at its heart is the agency’s bond portfolio, whose value has plummeted as interest rates rise. So it’s no surprise that analysts and investors are scrambling to find similar treasures elsewhere. Japan has made a disturbing discovery. Investment institutions there have amassed large inventories of domestic and foreign long-term bonds.
These holdings have plummeted in value due to sales and revaluations that occur when interest rates rise — a possibility known as “duration risk.” Long-term foreign bond holdings of “other financial firms,” which include insurance companies, investment institutions and pension funds, hit $1.5 trillion in June, the most recent data available, about $293 billion below levels at the end of 2018 USD 2021.
Japanese investment firm Norinchukin Bank is one of the holders of such bonds. The company has been a large buyer of mortgage obligations, bundles of loans secured by a single product. The value of its bond portfolio, hit by rising interest rates, fell to 28trn in December from 36trn ($293bn) in March last year. Japan Post Bank, a savings bank that is nearly one-third owned by the Japanese government, is another exposed institution. Foreign securities have risen from essentially zero in 2007 to 35% of total company holdings.
Clients of these agencies may not be as SVBof. In Silicon Valley, the run was led by panicked venture capitalists. Japan Post Bank has an army of individual savers across the country, with about 120 million accounts. Norinchukin Bank’s customers, mainly agricultural cooperatives, don’t seem to be fleeing as excited techies.
However, there is a risk of currency fluctuations. As Brad Setser of the Council on Foreign Relations think tank points out, rising US interest rates make hedging currency risk much more expensive. That’s true for investors as well as the companies and governments they’ve bought bonds from. Japanese investors sold $165 billion more in long-term foreign bonds than they bought last year, the most on record. Rising interest rates have caused bond issuers in large swaths of the world to pay more to borrow. The disappearance of previously reliable buyers only adds to the pain.
Large holdings of foreign financial assets are only one element of risk. Interest rates in Japan have been among the lowest by global standards since the early 1990s, after the country’s notorious land and stock bubbles burst. Three decades of relative economic stagnation and occasional deflation meant bond yields were very low, prompting financial institutions to turn to yen-denominated long-dated bonds for modestly higher returns. That adds to the damage that even a modest tightening of monetary policy could do.
But it is increasingly unclear whether Japan will actually be able to maintain its low interest rate policy. Consumer price inflation rose to 4.3% in January; wages at big companies look set to grow at their fastest pace in decades. A one percentage point rate hike would shave more than 9 trillion yen off the value of banks’ yen-denominated bonds. Big banks’ unrealized losses would be equivalent to around 10% of their capital.those in Shenjin Banks, the type of credit union, will still be higher, around 30%.
Last year the Bank of Japan (boj) showed that these losses would be more than offset by changes in the value of liabilities. The pressure has been eased by the rates banks offer savers, which tend to rise much slower than the rates they charge on new loans. The analysis shows that, for regional banks, these two forces almost completely cancel each other out. But the central bank’s calculations depend on assumptions about the loyalty of depositors. It is certain that rising interest rates have caused bank portfolio values to plummet; the stickiness of depositors has not been tested of late.
this boj insisted there was still no prospect of a rate hike. But recent inflationary pressures and a rise in the rest of the world mean that line is getting harder to hold. The mere possibility of an increase has had an impact on foreign bond holdings as investors dispose of assets. Global issuers of corporate and government debt are losing once-reliable clients just when they need them most, as Japanese institutions shift from buyers to sellers. ■
For more expert analysis of breaking economic, financial and market news, sign up for Money Talks, our subscriber-only weekly newsletter.