Sovereign borrowing: JGBs wobble over 2011 fears

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: SContreras@Euromoney.com

By:
Lawrence White
Published on:

Observers of the Japanese government bond market are sounding a note of caution at the start of this year, amid concerns that the domestic investors that have propped up the market for so long might finally lose their nerve.

In a research note published on January 5, Bin Gao of Bank of America Merrill Lynch Global Research argued that the market looked nervous. "When rates, normally moving 1.5bp a day for the last two years, jump 10bp one day and another 6bp a couple of days later, heads turn," he wrote. "That was what happened in the JGB market in mid-December before the close of 2010, supposedly a good year for buying JGBs."

Debt support

Japan’s extraordinary level of debt has been supported for decades primarily by local investors, both institutions and individuals whose savings are recycled via deposits at the big banks into the JGB market. That activity has increased in recent years: as Gao points out, the megabanks have increased their holdings – ¥20 trillion ($241 billion) between November 2008 and October 2010 in the two-year to 10-year range – to the point where changes in their overall positions move the entire market. That trend is in turn driven by the need for the megabanks to park their deposits somewhere: JGBs offer the natural outlet when the loan growth rate is negative.

"If the yield curve looked at all attractive then investors would be fine staying in low-yielding JGBs but my clients are increasingly asking about alternatives," says a fixed-income trader at a bank in Tokyo. "The only consolation is the poor performance of domestic equities and the concerns over sovereign defaults outside Japan... JGBs are still safe enough."

Gao’s report agrees with the trader that the threat to JGBs is more that investors will withdraw support than that there is a genuine threat of default, and argues that the Bank of Japan has some ammunition left in the form of balance sheet that it could use to intervene in the market. Nonetheless, fixed-income experts in Japan have been pondering for years when the tipping point is reached at which JGBs start to slide as investors fail to keep pace with the country’s ravenous appetite for borrowing. This year could be a nervy one for JGB holders.