Japanese bond volatility appears to have crossed the Rubicon. As we noted here [5], the Japanese Ministry of Finance warned that a rise in JGB volatility could cause a significant sell-off in JGBs (since banks will be hampered by their VaR models-driven risk limits, which have literally gone off the charts in recent days, and be forced to reduce holdings to meet those risk limits). It seems however, that since the BoJ is set to buy more JGBs than will be issued in the next several years as noted yesterday [6], that financial institutions are chosing to live with the record vol noted previously [7], opting to raise cash buffers and liquidity reserves instead of selling bonds in order to meet surging margin demands on their JGB holdings. The synchronicity between the price of gold (and other commodities) and the volatility of Japanese bonds makes this risk-driven perspective very clear. This leaves the question, what happens when the Japanese (or in fact global - since front-running the BoJ has been a big winner until a week ago) banks run out of 'other' assets to sell and their VaR models continue to demand more capital in reserve?
Since QE2, gold (and other commodities) have moved in inverted-lockstep with Japanese interest rate implied (and realized) volatility as the JGB margin demands oscillate.
[8]
Charts: Bloomberg