It’s summer, and many traders are already enjoying their holidays and stock portfolio gains, which are growing every passing day, regardless of the circumstances. No matter that the underlying economies are falling more and more into a dark hole, a larger number of people are struggling to make ends meet, and the uncertainties about the future remain elevated, especially due to the big global trade mess that began on “liberation day”. It feels like ages, but just one year ago, we were about to experience exactly during this period one of the biggest financial market turmoils of the recent past, with regard to some metrics even worse than what happened in 2020 or in 2008. On Monday, the 5th of August 2024, the Japanese stock market came very close to a total implosion, and that would have dragged down with it many other major financial markets, especially the US one, as a result of the forced unwinding of hundreds of billions of USD in leverage linked to the JPY carry trade.
I was one of the few people warning non-stop about the risk of the JPY carry trade and all the brutal consequences for the global financial system, way before the events unfolded (articles archive), till the days just before the chaos reached its apex. I suggest reading the articles I wrote at that time, since the information there will be important to understand today’s article:
- 2nd August 2024: “A TRAVELER GUIDE TO NAVIGATE THE BANK OF JAPAN MESS“
- 4th August 2024: “IN JAPAN IT WILL BE A MESSY MONDAY, BUT NOT A BLACK ONE (YET)“
Alright, then what the hell is going on today when “everything is awesome” and there should be nothing to worry about, according to the non-stop bullish narrative being fed to the public? Because interest rates are not buying the “everything is awesome” narrative, and instead of broadly coming down as many politicians wish, particularly the long-duration ones, losses are mounting in the belly of banks, shadow banks, insurances, and pension funds. The situation, already bad, is becoming seriously dangerous in Japan due to the specific composition of many institutions’ portfolios in the country: predominant holdings of long and ultra-long duration illiquid fixed income assets, both in local and foreign currency.
Just a few months ago, this headline briefly made global investors (slightly) uncomfortable: “Japan’s biggest life insurers post $60 billion in unrealized bond losses“. In the article “THE PERFECT STORM IS NOW STARTING TO HIT JAPAN’S FINANCIAL SYSTEM” I posted a few days later, I warned once again, like a broken record, how interest rates would have continued to remain elevated and heading higher, digging a deeper and deeper hole into the balance sheets of Japanese financial institutions. In the following months, the BOJ successfully managed to contain and cool down JGB yields, especially the ultra-long 30-year and 40-year, thanks to constant and timely market interventions along with relentless money printing through JGBs open market purchases (that only briefly slowed down). Despite promises of hiking rates and trimming the ballooning of its balance sheet, a few weeks after the whole world acknowledged the hole in Japan’s insurance system, the BOJ surprised markets and announced that due to “new risks” it would delay its bond tapering plans to 2026 (BOJ to slow pace of bond tapering next year as fresh risks emerge). What risks was the BOJ blaming? Increasing economic uncertainty due to US Trade policy developments. What a joke.
An even funnier joke is Wall Street analysts’ expectations for the BOJ to resume rate hikes in the near future. In the same way all these clowns failed to foresee the risks of a BOJ increasing rates after years at zero that later on unfolded with the near implosion of the JPY carry trade last year on the 5th of August, they are failing to foresee that the BOJ didn’t fix the structural problems of the Japanese financial system but only successfully managed to delay them into the future in what later on has been confirmed as an orchestrated bailout coordinated between them and Japan’s GPIF (HOW COULD JAPAN RECOVER SO FAST FROM THE WORST CRASH SINCE 1987? THANKS TO ITS GPIF “ANGEL”).
Inebriated by the global euphoria for rising stock markets, virtually nobody in the mainstream media, Wall Street, or social media noticed how the frequency of BOJ market interventions continues to increase. Before, these were needed a handful of times a month, then they became weekly, then multiple days a week, and lately multiple times a day. There are 3 types of “extraordinary” interventions the BOJ uses, interventions that are meant to be a one-off, but clearly not anymore:
- Liquidity enhancement auctions are meant to provide targeted liquidity to primary dealers, ensuring market depth without distorting long-term yields.
- USD Funds supplying operations
- JGB Lending operations
For example, yesterday, like every Tuesday now, the BOJ performed a 1-week USD funds supplying operation that is now regularly needed to avoid significant T-Bills liquidation (with major impacts on the stability of money markets) from Japanese financial institutions in badly need of USD liquidity. Liquidations that still occur regularly, as I punctually flag every week on X (post). However, this time, this was followed by a JGB lending operation in the morning and then by one in the afternoon on the same day. So the BOJ performed a total of 3 interventions in a single day, and now the number of interventions required to stabilize markets is already 5-6 a week, usually on a Tuesday, a Thursday, and on a Friday before markets close. Yesterday’s intervention stood out particularly because, while government bond yields on a quiet summer day were mostly flat or heading lower, a sudden spike in 30-year JGB yields was enough to require the BOJ’s prompt intervention. JGB lending operations followed right after the morning and the afternoon’s sudden moves.
Even if a few basis points’ upward move might seem negligible nowadays, I would like to remind you how this impacts a portfolio overexposed to long-duration assets and how such an urge to sell bonds in an illiquid summer market is likely caused by a financial institution under stress. What kind of stress? Considering that the BOJ quickly took action and started to lend JGBs in the market, it is likely that the financial institution is facing margin calls. Believe me, if margin calls are being delivered to a financial institution when there is no particular volatility in the market, it always means that the financial institution’s counterparts are feeling more and more uncomfortable with its credit resilience and are demanding more collateral not to close their positions. When margin calls for significant amounts are being sent, the first thing a dealer does is to hedge its liquidation risk in the market, and in this case, it is likely that this JGB yields abnormal move was caused by short positions opened on JGB 30-year bonds. Thanks to JGB’s interventions, collateral was delivered on time, and any open market liquidation was avoided, but considering that yields did not come down thereafter is a sign that the counterpart dealer kept the hedging in place to match the risk on now a larger collateral position.
Needless to say that a financial institution in such poor shape as to not have collateral left to meet margin calls and not in the condition to liquidate assets to scale down its risk exposure, likely because that will result in the crystallization of significant losses both on the asset sale and the wind down of the position against the counterpart that sent the margin call, the situation of that financial institution is pretty critical.
At this point, it is fair to wrap things up, providing some guidance on which institution (hopefully only one) can be the one struggling to stay afloat. We already know that Norinchukin Bank, the second-largest lender in Japan, has been fighting against insolvency for quite a long time now (NORINCHUKIN BANK IMPLOSION OFFICIALLY BEGINS) and this bank is so important to the global financial system that it has been granted access to the Fed’s standing REPO facility as I flagged right away in 2023 (WHY IS THE FED PREPARING TO BAIL OUT A JAPANESE BANK? BECAUSE OF THE “NORINCHUKIN” DANGER) and, of course, a major development broadly ignored by mainstream media and Wall Street. We also know that SoftBank is running out of cash. Back in May, in the latest update on this institution, I wrote “SOFTBANK GOES ALL IN ON AI WITH THE LITTLE MONEY IT HAS LEFT” and clearly, the situation in the past months has been worsening, considering SoftBank is now public news that it is struggling to source the funding for the (nonsensical) Stargate project (SoftBank and OpenAI’s $500 Billion AI Project Struggles to Get Off Ground).
Among Japanese insurances, the total 8.5 trillion JPY amount of unrealized bond losses against 200 trillion JPY of assets, most of which are in illiquid long and ultra-long duration fixed income securities, is obviously very understated. However, due to the lack of transparency, it is hard to make a more accurate estimate. Just to give an idea, if an investor bought 30-year JGB bonds in 2022 and held them till today, the theoretical loss in face value of that investment will be ~35%. In the case of 10-Year JGBs, using the same assumptions, the unrealized loss today would be ~11%. These institutions are also notoriously invested in long-duration foreign assets, mostly in USD, like US treasuries, MBS, and CMBS, assets that currently are trading at a significantly lower price compared to the ones they held for a long time during the ZIRP years. Here is the list of the major Japanese insurance companies ranked by assets to capital ratio (the higher the ratio, the more solid, in theory, the insurance balance sheet). Feel free to make your own conclusions:
- Nippon Life: 9.5
- Meiji Yasuda: 10.5
- Sumitomo Life: 10.6
- Dai-ichi Life: 12.7
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