Brace For "VaR Shock" - How The Bank Of Japan May Be About To Unleash A Global Selloff

Tyler Durden's picture

As we pointed out recently, Japan has been quietly undergoing a mini bond tantrum as over the past two months, its sovereign debt suffered the worst rout in 13 years, handing investors bigger losses over the past two months than any other government bonds, amid speculation the Bank of Japan plans to change its asset-purchase strategy.

The selloff started in late July, around the time the time the BOJ disappointed with its latest announcement, and accelerated on fears that as part of its "comprehensive assessment" of its policies, the central bank would set back the BOJ's monetary easing stance. 

It then resumed in late August, after central bankers made another coordinated push for fiscal stimulus at Jackson Hole, which would mean more sovereign debt supply, and thus lower prices, all else equal. Then earlier this week, Kuroda said that a review of the current stimulus efforts due by the Sept. 20-21 policy meeting in which some analysts and investors read between the lines that the BOJ may be seeking to force a shift toward a steeper yield curve after the gap between two- and 30-year securities compressed to a record 30 basis points.

Kuroda on Monday also pointedly flagged concerns about negative potential effects from the slide in long-maturity bond yields. Earlier this year, rates as long as 20 years touched zero percent. The BOJ chief noted that the drop hurt returns on pension programs, and could affect confidence levels and the economy more broadly.

As Kuroda said, clearly highlighting the dangers of a flatter yield curve, "some business firms have revised down their profit forecasts due in part to the increase in the net present value of retirement benefit obligations. We should take account of the possibility that such developments can affect people’s confidence by causing concerns over the sustainability of the financial function in a broad sense, thereby negatively affecting economic activity.”

These hints prompted Evercore ISI analysts to suggest that Japan’s central bank in coming weeks will modify its stimulus program to alleviate risks from ultra-low long-term yields, by pursuing a reverse "Operation Twist", where the central bank sell long-end bonds while buying the short-end. 

The change would help to make the Bank of Japan’s easing more sustainable over the longer haul, given diminishing chances of hitting the 2 percent inflation target soon, according to the analysis by Evercore ISI's Krishna Guha and Ernie Tedeschi. “The BOJ’s policy review will point to a rebalancing of its monetary policy aimed at maintaining or increasing downward pressure on short-to-medium term real interest rates (and in turn put downward pressure on the yen) while engineering a steepening of the yield curve,” Guha and Tedeschi wrote in a note.

To avoid market fears that the central bank is seeking an outright tightening of monetary conditions, which a "reverse Twist" would suggest, the BOJ may cut short rates further from the current -0.20%. A cut in the already-negative benchmark rate, levied on a portion of banks’ reserves parked at the BOJ, which would also steepen the yield curve, could show the BOJ is still implementing unvarnished stimulus. The Evercore ISI analysts, cited by Bloomberg, said a rate cut could come either this month or later in the year.

It may not stop there: the BOJ could additionally add local-government or nonfinancial corporate bonds to its asset purchases. Another option could be to pledge an “overshoot” of the 2 percent inflation target, which would suggest avoiding any shrinkage of the balance sheet for an extended period. As the Evercore analysts added: "A core part of the operation would be shifting government debt purchases to shorter maturities, allowing ultra-long term yields beyond 10 years in particular to rise,” Guha and Tedeschi wrote. “The combination of credible aggression today with a commitment to maintain that and the associated balance sheet/rate settings longer into the future would in our view make the policy additionally effective."

* * *

On the surface, pushing for a steeper yield curve may seem like a good idea, and something which Japan's bank and pension funds will applaud. However, there is a problem: with trillions in long-dated JGBs carrying negative yields, a sudden withdrawal of support for the long-end could roil the market in a repeat of what happened to the 2013 US Taper Tantrum and the 2015 Bund Tantrum, when in a very short period of time, benchmark bonds were liquidated en masse, resulting in tens of billions in mark to market losses for investors.

As a result, the reversal is spurring concern the second-largest debt market is the vanguard for a broader selloff.

Cited by Bloomberg, Chotaro Morita, the chief rates strategist at Tokyo-based SMBC Nikko Securities Inc., one of the 21 primary dealers that trade directly with the central bank, said that "The impact of the BOJ’s stimulus is that the bond markets worldwide are becoming one market. If there’s a reversal of policy, you can’t rule out that it would roil global debt."

Indeed, as we have shown repeatedly out over the past few weeks, and as JPM's head quant, Marko Kolanovic, noted yesterday, with cross asset correlation soaring, not to mention with risk-party and CTA funds approaching record leverage, the risk is that investors frontrunning a perceived change in the BOJ's policy in two weeks time could lead to a dramatic selloff in JGBs, which then spreads across to global fixed income markets, all of which trade like connected vessels.

Another risk factor is that just hours before the BOJ announces what may be a seachange in policy, the Fed itself will announce its latest monetary policy decision, which - in the case Yellen raises rates by another 25 bps - will further add to market dislocation.

* * *

But why so much attention on Japan? Well, Japan’s sway over global debt has increased in 2016. The correlation between securities in Tokyo and a gauge of worldwide bonds has risen to 0.86 this year, from 0.58 in 2015, according to Bank of America Corp. indexes. A correlation of 1 would mean they moved in lockstep.

Goldman Sachs warned in May that Japan could be the catalyst for the next international selloff in bonds. While there’s no immediate danger of a global spike in long-term yields amid tepid inflation worldwide, any shift in the BOJ’s unprecedented asset-purchase plan would have a ripple effect, according to Goldman's Francesco Garzarelli.

“A change in tack by the BOJ would be felt on global bonds,” he said in e-mailed responses to questions on Wednesday.

Furthermore, in a note in early June, he also also warned that a sharp 1% spike in rates across the curve in the US alone, would result in MTM losses of $2.4 trillion.

That excludes the crossover impact into stocks, as a selloff in bonds leads to a correlated liquidation across equities, as a result of record leverage for Risk-Parity and other quant funds...

... for whom coordinated selling in both asset classes could lead to dramatic deleveraging, and a positive feedback loop of even more selling.

Risk Parity

As BofA calculated one month ago, "even a relatively benign 2% selloff of the S&P coupled with just a 1% selloff of the 10Y could result in up to 50% deleveraging, which in turn would accelerate further liquidations by other comparable funds, and lead to a self-fulfilling crash across asset classes."

A central bank-prompted market fiasco won't be new: in 2015, it was euro-area government debt that was in the driving seat for fixed-income markets around the world. Traders were caught off guard as nascent signs of inflation and euro-zone economic growth fueled a bond rout that began in Europe and quickly spread. The 10-year German yield surged by more than one percentage point in less than two months, and the Bloomberg Global Developed Sovereign Bond Index lost more than $750 billion in market value between April 29 and June 5 last year.

Meanwhile, the selloff in Japanese bonds, as shown in the top chart, has already begun: Japan’s government debt has tumbled 2.1% this quarter, heading for its steepest such loss since 2003.

Making matters worse, the rush among Japanese investors to seek income in bonds abroad after Japan's launch of Negative rates in January, have now started to dry up.  Japanese investors sold a net 1.33 trillion yen ($13.1 billion) of overseas debt in the week ended Sept. 2, unloading securities for the first time since June, according to Ministry of Finance data. That was after buying 4.72 trillion yen of U.S. sovereign bonds in July, the biggest amount in ministry data to 2005 after the record 4.95 trillion yen they purchased in March.

“Japanese purchases of Treasuries have stopped temporarily,” said Hideo Shimomura, the chief fund investor at Mitsubishi UFJ Kokusai in Tokyo. “Long-term yields in Japan have risen. Money will be coming back." Incidentally, three months ago the world was shocked to learn that Mitsubishi UFJ had appealed the BOJ to quit as a primary dealer for the rapidly shrinking JGB market.

Which brings up another point: with virtually no sources of liquidity on either side of the market, the BOJ holding a third of all Japanese treasuries, and banks no longer actively involved in market making of JGBs, the market has never been more illiquid.

Which means that any coordinated selloff of longer-dated yields would certainly result in the infamous "VaR shock" which sent shockwaves across Japan in 2003. Recall that in early June, BOJ board member Takehiro Sato already knew which way the wind was blowing. As we wrote at the time, this is what he said:

Financial institutions are facing the risk of a negative spread for marginal assets due to the extreme flattening of the yield curve and the drop in the yield on government bonds in short- to long-term zones into negative territory. When there is a negative spread, shrinking the balance sheet, rather than expanding it, would be a reasonable business decision. In the future, this may prompt an increasing number of financial institutions to take such actions as restraining loans to borrowers with potentially high credit costs and raising interest rates on loans to firms with poor access to finance.


...a weakening of the financial intermediary functioning could affect the financial system's resilience against shocks in times of stress. In addition, an excessive drop in bond yields in the super-long-term zone could also make the financial system vulnerable by increasing the risk of a buildup of financial imbalances in the system.

He concluded by saying that from financial institutions' recent move to purchase super-long-term bonds in pursuit of tiny positive yield, "I detect a vulnerability similar to that seen before the so-called VaR (Value at Risk) shock in 2003."

* * *

So will the BOJ shock markets and unleash this year's "bond tantrum", one which would come at a time when there is an unprecedented $13 trillion in negative yielding bonds? According to Old Mutual Global Investors which oversees the equivalent of about $436 billion, a policy change aimed at steepening the yield curve wouldn’t be surprising, even though it would come at the expense of bondholders.

“It would definitely see some pain,” said Mark Nash, head of global bonds at the London-based fund manager. “Money flows across borders. It’s all linked.

How much pain?

If Sato, and Goldman, are right, and the BOJ is about to unwittingly launch a repeat of the 2003 VaR shock, this much:

What that selloff - in a time of soaring cross-asset correlations, record quant leverage and virtually non-existent market liquidity - would mean for equities, we don't know, - but thanks to Haruhiko "Peter Pan" Kuroda, we will soon find out.

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espirit's picture

Lot's of "ripples" in the Matrix lately.

Got Collateral?

Dizzy Malscience's picture

..maybe the only question is that when the tsunami hits, does the average Japanese household safe displace enough water so that it floats back to the west coast of the United States like all of the plastic flotsam….

Manthong's picture

Maybe the better question is how many zillion Bq’s do the safes have.

WordSmith2013's picture

JAPAN: An Economy On Life Support And The Looming Financial Disaster



"The Economic collapse of Japan is a Prevailing Gray Swan."

kliguy38's picture

I don't see any moar stawks and STFU!

SomethingSomethingDarkSide's picture

Krugman just ordered a plate of Kuroda's finest Creme de Sum Yung Gai

BuddyEffed's picture

More bad spin to feed the short buyers with and set them up for the short covering rally

johngaltfla's picture

I knew there was a reason my inner self told me to buy another case of beer today. And it wasn't just for the NFL and Fan Duel or my STIB (Short Term Investment Broker).

GreatUncle's picture

Yup ... and those running the show just fleeced more that will not now be used to grease the real economy.

Eventually there is no significant economy in real terms .... do carry on.

johngaltfla's picture

There's a name for what you describe from the book "The Creature from Jekyll Island"'s called "the harvest"....

And it's about to start, just like 2008.

max2205's picture

Fed got your back. ....doggie style. 

BandGap's picture

Didn't Kuroda ask for some help a few months back?

So solly.

pods's picture

This is like a relay race for Central Banks. Every time one tires of printing joobucks, there is another fresh one waiting in the wings.
That way nobody's currency gets whacked too much and the game can continue.

Just don't see this blowing up the world, sorry.  The Hanjin debacle has a greater chance, as that actually deals with physical goods, not conjured up joobucks and bonds.


KickIce's picture

Just more 1s and 0s on a computer screen, and maybe an extra set of books.

SomethingSomethingDarkSide's picture

Real Estate was saved by purchasing $ Trillions in CDO's.  I don't see any of those for containers and late delivery contingency costs.  At least nothing that would be completely in the clear legally from a Fed Mandate point of view.

KickIce's picture

But they can still print without consequence.  IOW, if a member of the tribe got hurt by this they will be made whole while everyone else will take it up the wazoo.

sdmjake's picture

I think you are right Pods...this isn't going to "blow them up". Following is a link to an interesting article that addresses the next step in the global debt plan:

It allows the IMF to act as the cartel that swaps out all this sovereign crapola. This keeps your oligarchs in control and continues screwing your sheeple. Not implying you should stop stacking,etc but i think this shitshow is going to continue getting drawn out like a blade...

GreatUncle's picture

IMF one of the heads of the beast, with NATO and the UN.

This could go on for a long time the real issue is will the ordinary people start getting pissed off when they have nothing and are forced to live in poverty. Not there yet on its way though ...

The poverty is a relative one though, all the value held by the elites that needs to provide a return against those at the bottom unable to earn enough to keep their current position as thed top sucks everything up.

debtor of last resort's picture

And that's when the worldwide CB circle jerk comes in.

BoJ didn't buy Apple stock for nothin, Japan goes, everything goes.

Come and get me.

GunnerySgtHartman's picture

And TPTB say that 'Globalism' is the only way to go ...

Butter-Cup's picture
Butter-Cup (not verified) Bush Baby Sep 9, 2016 9:15 AM

My last pay check was $9500 working 12 hours a week online. My sisters friend has been averaging 15k for months now and she works about 20 hours a week. I can't believe how easy it was once I tried it out. This is what I do...

Herd Redirection Committee's picture

So let me get this straight, if the stock market crashes, its Donald Trump and BOJ's fault?

Tim Knight from Slope of Hope's picture

Here's what Hillary has to say to that question: cough cough cough cough cough cough cough cough wheeeeeeeez

Bush Baby's picture

No --- They'll blame it all on Trump, because " The world will be so traumatized by his election"


Too bad these ma-NIP-ulators don't do the honorable thing anymore

Snaffew's picture

that was racist, but amusing nonetheless

Citizen_x's picture

or Putin, Iran, Turkey, China, etc....

E5's picture

Threat will be enough.  Guess we know why the fed is begging to detach the banks.  They lost control at the G spot summit.  World Currency War has begun.  The bombs are in the airwaves.


Snaffew's picture

the currency players have all been making their moves as if they were playing Parker Brothers Stratego board game...noe the sheet is starting to get real...this low volatility environment should start to pick up.  Looking for some strong market oscillations as an indicator the end is finally near for this bull market.  It's been painfully flat trading.

Bill of Rights's picture

Good its getting boring around here, let see some sparks fly.

scraping_by's picture

"the BOJ may cut short rates further from the current -0.20%"

As a gaijin wage-earner here in the flyover region of 'Murica, I can only watch and wonder at being paid to borrow money.

I'd park their Yen for them. Sounds like a tough one but rednecks get the job done.

aliens is here's picture

So what? I hate the Japs. Plenty of my relatives were killed by the Japs.


Philo Beddoe's picture

Your relatives all drive Toyotas? 

aliens is here's picture

Bombs and bullets. They'll do it again if they have the opportunity.

niemand's picture

central banksters forced the empire to act. after a couple of sanctions ( oil!) the `japs´acted.

bring your knowledge up to date. ever heard of internets? no..not the porn sites; the boring stuff

yogibear's picture

Killing the Japanese economy, with Fed Keynesian tactics.

Mountainview's picture

First Pearl Harbour and now this...

Mountainview's picture

all of them should be fenced in...

niemand's picture

we got used to it. as long as America stays exceptional, indespensable everything will be awesome. Sieg H..l   USA 

aliens is here's picture

The Germans will fuck up Europe again.

niemand's picture

ignorance is strength. just stay exceptional..ignorant



Kirk2NCC1701's picture

And yet PMs are down.  [frowns, rolls eyes, takes deep breath]

 Riddle me that.


GotNuttin'todo's picture

Patience my cosmic rittle friend. Grasshopper must

have great patience.

Consuelo's picture



-Yet another SGE buying opportunity me thinks...

wisehiney's picture

One of their little games.

They know better than to go to far.

I'll be waiting if they do.

adanata's picture


Patience Captain, patience.

Kirk2NCC1701's picture

Lord, give me patience, and give it to now.