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French elections worry Japan’s bond investors

The French presidential election is setting up a critical test of resolve for Japanese investors as life assurers, big banks and struggling regional lenders enter a second year under the Bank of Japan’s negative interest rate policy.

The policy shift by the BoJ in February 2016 accelerated efforts by Japanese investors to seek higher fixed-rate returns overseas and has raised the sensitivity of their portfolios to global political uncertainty.

A Tokyo-based bond trader said: “Japanese investors have learnt the hard way not to trust the polling, or the idea that the ‘old world’ is low on political risk”. This comes after two disorientating shocks in the form of the UK’s Brexit vote and the election of Donald Trump as US president in what Japan had previously viewed as the stable developed markets, he added.

Concern over the rising nervousness of Japanese investors and any rebalancing of their ¥270tn mountain of overseas bond holdings was highlighted last week by Ministry of Finance data from February showing that, for a third month running, Japanese banks and insurers sold more than ¥1tn of foreign bonds. The selling has come as top-tier country benchmark yields have risen sharply since late last year on signs of stronger growth and rising inflation.

The potential cloud over French debt appears particularly dark. Japanese institutional investors have nearly tripled their weighting of French bonds since the end of 2011 to an estimated 10 per cent of the total portfolio at the end of 2016 — a total value of ¥27tn and second only to their ¥122tn holdings of US bonds. Momentum increased in the early part of 2016 as institutions shunned Japanese government bonds after the 10-year JGB benchmark yield turned negative last February.

Ryoko Tada, a rates strategist at Nomura, said that while a majority of Japanese investors were adopting a “wait and see” stance on the French election, some were preparing for a risk scenario in which Marine Le Pen defied predictions and won. She expects the steady sell-off of foreign bonds by Japanese to continue at elevated levels until the result is known in early May.

The French electoral showdown comes as warnings are being expressed over the vulnerability of Japan’s regional banks sector. This group already suffers acutely from the country’s ageing demographics, while also being scared by the implications of the Toshiba scandal, and under pressure to expand into areas where they have only limited expertise.

Analysts said comparatively strong-looking recent results for the quarter ending December 2016, were only robust because regional banks had profitably sold equities to offset higher unrealised losses on their overseas bond portfolios following the post-election rise in US yields.

Reports in Japanese media last week suggested that Japan’s Financial Services Agency was launching investigations of asset management divisions of regional banks to establish their risk management strategies and level of exposure to foreign bonds as paper losses on US Treasuries expand.

“The FSA is genuinely concerned that the BoJ is putting them in a position of having no alternative to increasing their risk profile by going overseas or chasing longer duration notes,” said one banks analyst. “It could all end badly, and this was intended as a warning shot.”

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