BOJ Faces $200 Billion Hit If It Loses Control of the Curve

(Bloomberg) — The Bank of Japan would face a huge loss on its super-sized holdings of government bonds if it were to buckle under ever greater market pressure and abandon its easy monetary policy as hedge funds rush to short the debt securities.

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Thanks to its quest to boost prices in deflation-prone Japan, the BOJ now owns 526 trillion yen ($4 trillion) of government bonds — almost half the total — an amount that rivals the size of the economy. As an increasing number of investors question how much longer the central bank can stick to its ultra-easy stance, traders will keep a close eye on its policy announcement Friday and comments by Governor Haruhiko Kuroda.

A shock policy shift could lead to a paper loss of 29 trillion yen ($219 billion) on the BOJ’s bond holdings, calculations by Bloomberg based on central bank data show. That’s under a hypothetical scenario where the entire yield curve shifts upward by 100 basis points.

While any losses would be unrealized and would come after gains over time in other holdings, they would be mirrored across Japan’s financial institutions, complicating any BOJ push to normalize interest rates.

“Governor Haruhiko Kuroda will find it challenging to normalize along the Fed, as a rate hike would trigger losses on banks and lifers’ balance sheets, as well as the BOJ itself, given that it holds the majority of JGBs issued,” wrote Natixis economists Alicia Garcia Herrero and Kohei Iwahara in a note Thursday. “Nevertheless, with the current unsustainable situation, the BOJ would need to devise a plan quickly.”

Speculators pushed Japan’s bond futures to the brink of a trading halt Wednesday, as the BOJ struggles to convince markets its pledge to cap yields at 0.25% is sustainable. Signals from the option market show bets on a tweak to its curve-control policy are mounting as it increases bond buying to historic levels.

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Demand to hedge one-day price swings in the yen ahead of the BOJ’s meeting Friday is the highest since March 2020.

Although it’s a highly unlikely assumption, a removal of the BOJ’s so-called yield curve control would cause a seismic change in the market. Mizuho Securities Co., for instance, estimates the 10-year yield — currently capped at 0.25% — could spike above 1% if the BOJ were to abandon its policy of pinning the rate around zero.

“We think that JGB selling will intensify as more and more market participants are getting involved in shorting Japan’s longer dated bonds,” said Amir Anvarzadeh, strategist at Asymmetric Advisors Pte in Singapore.

In Australia, when speculation grew that the Reserve Bank would abandon its yield target, the benchmark three-year yield surged more than 100 basis points in about a month.

The BOJ’s strategy of unlimited debt purchases to cap yields this year has given an additional boost to its bond holdings, just as peers like the Federal Reserve begin to reduce theirs.

(Adds yen positioning in seventh paragraph.)

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