The FSA Est Arrivé

Sayonara, European Bonds

Japanese investors have a lot of selling in store.

Japan's financial year-end is one of those seasonal factors that can have an outsize impact in global markets. Funds squaring up to close their books on March 31 usually reduce risk both home and abroad, only to pile back in when the year starts in April.

Not this time. There's more volatility in store in Europe, and for this you can thank Geert Wilders and Marine Le Pen. The region's debt markets are in for a sharp lesson in what happens when Japan's regulators take a stand against risk. 

A significant driver of European market volatility recently appears to have been Japanese investors suffering a reality check that French government bonds are not merely higher-yielding bunds.

Open interest in the 10-year French government bond future has hit a record -- meaning there are the most active contracts, of both short and long positions, ever. This is likely partially due to Japanese investors hedging their French exposure. That's what happens when you raise your French holdings and then a right-wing nationalist takes the lead in voter opinion polls -- yields jump up, and that creates a rush for the exits, which is translating into increased activity in the futures markets. 

Record Exposure to French Bond Futures

Since the back end of 2016 the rolling hedges to French debt have nearly trebled

Source: Bloomberg

It's a far cry from last year. Negligible yields and a weakening yen made foreign debt all the rage in Japan, and that included a deep dive into Europe. This continued a post-crisis trend that saw investors almost triple their holdings of French securities, making them at one point their second-largest overseas debt holding after U.S Treasuries. They've also been large investors in other core European bond markets, including the Netherlands, believing them to be safe diversification from bunds, but with extra spread.

This was all going swimmingly until the Brexit vote. That wobble was worsened by the election of President Donald Trump. Japan's benign view of European stability has been undone.

The Japanese regulator, the Financial Services Agency, has made it expressly clear that they will be investigating, and even taking residence in, regional banks that have taken losses on foreign government bond holdings. It would be a bold Japanese fund manager that maintains, let alone increases, risk to overseas bonds. So even the higher yield in, say, French debt, and the currency advantage from being someplace other than the yen, are no match for having the regulator take the desk right next to yours. 

Keeping a Lid On It

The Bank of Japan targets zero yield on 10 year debt, 10bps is its max tolerance

Source: Bloomberg

The Bank of Japan's policy of yield targeting means they'll act to ensure domestic yields do not rise significantly above, for instance, zero percent on 10-year government securities. This is all part of official policy to strongly encourage life insurance companies, pension funds and bank investors to stay at home. At least they won't be taking any foreign losses, which is nice. 

The flight has already started, with data from Japan's Ministry of Finance last week showing that Japanese investors have reduced holdings of French debt for three consecutive months, the first time this has happened since the height of Europe's financial crisis. At the start of 2017 their share of the French government bond market was as much as 13 percent. Even with the selling that's already happened, there's likely still a long way to go before Japan's happy with its exposure.

With the Dutch elections on Wednesday, U.K. Prime Minister Theresa May due to trigger Article 50 in March, and the result of the French Presidential election not due until May, April may wind up being another cruel month for European bonds. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Marcus Ashworth in London at

    To contact the editor responsible for this story:
    Jennifer Ryan at

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