Government debt is generally considered one of the safest havens for investors in turbulent times. Institutional asset managers, in particular, could not do their jobs without the backstop of sovereign bonds as a foundation for their portfolios – offering stability and predictability.
So, the recent travails which saw the Japanese bond market come under relentless pressure must have kept some insurance asset managers awake many nights. Hedge funds had made massive speculative bets on Japanese government bonds and bought them up by the armful – complicating the picture for more traditional bond investors.
In recent weeks the Bank of Japan (BoJ) demonstrated that it was not about to abandon its ‘yield-curve control’ policy and showed commitment to the foundations of its ultra-loose monetary policy – while at the same time offering loans to banks for up to 10 years at variable rates instead of the prior rate that was fixed at zero.
This should result in a more stable yield curve – and predictability for insurance asset managers.
Predictability is great – but Japan’s insurance sector still faces its highest core inflation rates since the early 1980s at around 4% and well ahead of the BoJ’s target of 2%. The inflation is being driven by a weak yen and heavy reliance on imported goods.
Anxiety over this elevated inflation rate, although still mild by global standards, could cause a real headache for the insurance sector if it feeds into wage inflation – which has a tendency to become a cyclical problem.
However, the unspoken challenge facing Japanese insurance asset managers is what happens when the BoJ finally gives up on yield curve control?
In a recent article, ‘The Disappearing Japanese Bid for Global Bonds’, Council on Foreign Relations senior fellow Brad Setser and Exante Data senior macro strategist Alex Etra said, “Japanese investors have bought enormous quantities of foreign bonds over the last 20 years. Total holdings of foreign bonds by ‘private’ Japanese institutional investors … reached $3tn at their peak.
“It is no exaggeration to say that Japanese flows have had at least as much of an impact on the global bond market as Chinese flows over the last decade - and there is now understandable concern about the risks posed by large potential shifts in the portfolio of Japan’s institutional investors.”
Chief among Japan’s institutional investors would be insurance asset managers.
The authors go on to say, “The Japanese outflow should not be thought of as a single flow, as it is not driven by a single dynamic. Rather, Japanese institutional investors invest abroad for three distinct reasons: The absolute yield pickup available on unhedged bonds given low Japanese rates; a steeper yield curve outside of Japan than inside, and thus the opportunity to make money on currency-hedged bonds; access to the global corporate bond market, and thus the opportunity to collect credit spreads that are hard to find inside Japan. Japanese companies are (famously) cash rich and thus have a limited financing need.”
It is a complex picture and one that Japanese insurers have handled well in the past. But the global macroeconomic picture has been made infinitely more complex by the pandemic, Russia president Vladimir Putin’s invasion of Ukraine and more.
Japanese insurance asset managers will be watching the situation very closely.
Paul McNamara
Editorial director
Asia Insurance Review