tHe died Silicon Valley Bank had many reasons. But at its core was the institution’s bond portfolio, which has plummeted in value as interest rates have risen. It’s no surprise, then, that analysts and investors are scrambling to find similar objects elsewhere. One disturbing discovery lies in Japan. Institutional investors have accumulated huge stocks of long-term domestic and foreign bonds.
These bond holdings have already depreciated in value, thanks to a combination of sales and revaluations that happen when prices go up — the likelihood of which is known as “duration risk.” Long-term foreign bond holdings by “other financial firms,” a category that includes insurance companies, institutional investors and pension funds, reached $1.5 trillion in June, the latest figure available, about $293 billion below their level at the end of 2021.
Norinchukin Bank, a Japanese investment company, is one of the holders of these bonds. The company has been a huge buyer of collateralised loan obligations, packages collateralized loans into one product. The value of its bond portfolio has been squeezed by rising interest rates, from 36 trillion yen ($293 billion) in March last year to 28 trillion yen in December. Japan Post Bank, a savings bank that is roughly one-third owned by the Japanese government, is another exposed institution. Foreign securities rose from essentially zero in 2007 to 35% of the company’s total holdings.
Clients of these establishments are likely to prove less irritable than svb‘s. In Silicon Valley, panicked venture capitalists led the race. Japan Post Bank has an army of individual depositors across the country, with about 120 million accounts. Norinchukin Bank’s clients, most of whom are farming cooperatives, seem less likely to run away from interesting types of technology.
But there are risks from currency movements. As Brad Setser of the Council on Foreign Relations, a think-tank, notes, rising US interest rates have made it much more expensive to hedge currency risks. This is true for both the investors and the companies and governments from whom they have previously purchased bonds. Japanese investors sold $165 billion worth of long-term foreign bonds than they bought last year, the largest sale ever. Rising interest rates are making bond issuers across large swathes of the world pay more to borrow. And the disappearance of previously trusted buyers adds to the pain.
And massive holdings of foreign financial assets are just one element of the risk. Japanese interest rates have been at their lowest by global standards since the early 1990s, after the country’s infamous land and equity bubble burst. Three decades of relative economic stagnation and occasional deflation have driven down bond yields, prompting financial institutions to turn to long-term yen-denominated bonds for modestly higher returns. This increases the amount of damage that tighter monetary policy might do.
But it is increasingly unclear whether Japan will actually be able to maintain its low-price approach. Consumer price inflation rose to 4.3% in January. It appears that wages at large companies will rise at their fastest pace in decades. A one percentage point hike in the interest rate would wipe out more than 9 trillion yen of the value of yen-denominated bank bonds. Unrealized losses in major banks would equate to about 10% of their capital. those in Shinkin Banks, and credit union types, will still be higher at about 30%.
Last year, the Bank of Japan (Baj) published analysis indicating that these losses will be offset by the variable value of liabilities. The interest rates banks offer depositors tend to rise much more slowly than they charge on new loans, which relieves pressure. The analysis indicated that for regional banks, the two forces would almost completely equalize. But the central bank’s calculations depend on assumptions about depositors’ loyalty. A decline in the value of bank portfolios is certain as a result of higher interest rates. The viscosity of depositors has not been tested recently.
the Baj He insists that there is still no possibility of higher interest rates. But inflationary pressures and recent hikes in the rest of the world mean that this line is becoming more difficult to hold. The mere possibility of an increase is already affecting foreign bond holdings, as investors dispose of the assets. And as Japanese institutions turn from buyers to sellers, issuers of government bonds and global corporations are losing once-trusted customers, just when they’re desperately asking. ■
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