Dai-Ichi Life sees falling volatility in JGB market
The surging bond yields that have saddled Japan's insurers with billions of dollars in unrealized losses will weaken because they are not supported by economic fundamentals, according to Dai-ichi Life, the country's largest listed life insurer.
New buyers are entering the market for Japanese government bonds and amplifying volatility, Chief Executive Officer Tetsuya Kikuta said in an interview. Yields on 30-year JGBs jumped to a record last week. This is eroding the value of the bonds already in the insurers' portfolio. Dai-ichi's paper losses on its domestic bonds stood at about ¥2 trillion ($14 billion) as of the end of March.
A rout in Japan's $7.8 trillion government bond market has spooked several firms including Nippon Life Insurance and Norinchukin Bank. The Bank of Japan is paring its holdings in the face of emerging inflation, sparking a selloff in the country's long-term debt. The current run-up in yields is a stark reversal for the companies, which until just a year ago had been suffering diminishing returns from domestic investments and desperately seeking more attractive assets overseas.
"There are a very limited number of long-only JGB investors and they are being replaced by short-term players,' Kikuta said. "That's pushing up the JGB market's volatility.'
While yields could jump further in the near future because of a lack of liquidity, the JGB market will likely calm down around the end of the year, Kikuta said. Swap rates are roughly 60-125 basis points lower than comparable JGB yields.
"Japan's potential economic growth rate is less than 1%. And inflation only affects shorter-term interest rates. So, fundamentally, I don't think long-term rates should be where they are now,' said Kikuta. "They are just overshooting temporarily, due partly to supply and demand.'
Yields on Japanese super-long bonds fell ahead of an auction Wednesday that is expected to test demand following a recent sale that sent jitters through global markets. Yields on 40-year and 30-year maturities slid 10 basis points in Tokyo on Tuesday, adding to drops in recent days. These moves followed sharp gains last week.
Dai-ichi's domestic insurance unit owns ¥16.6 trillion worth of JGBs and municipal bonds as of the end of March, and more than half of the holdings have maturities of over 20 years.
Japan's life insurers have traditionally been the main buyers of JGBs with maturities as long as 40 years to cover obligations spanning decades for insurance policyholders. Recently, hedge funds have been increasing their trading of Japanese bond futures and yen rate swaps.
Paper losses do not pose an immediate risk to the insurers and under a new rule, higher interest rates push down the value of both assets and liabilities and do not affect a regulatory gauge of fiscal soundness.
While the current yields are already "very attractive,' the insurer now has little room to buy fresh JGBs, as it is almost done with a regulation-driven buildup, Kikuta said. The company will keep replacing lower-yielding bonds with higher ones, he added.
The company is pulling back on foreign bonds with currency hedging, which were one of the mainstays for insurers during Japan's period of low interest rates. The company is also cautious on buying foreign bonds without currency hedging, given the risks of a stronger yen in the future.
"The need has shrank a lot for foreign bond investment as a replacement for yen-interest assets,' Kikuta said, adding high hedging costs make it hard to justify them. "Things which were unthinkable just a short while ago are happening now,' he said.
Dai-ichi has been aggressively expanding beyond traditional life insurance in Japan and focusing on asset management as one of its growth areas.
Earlier this month, the company said it plans to acquire an additional stake in U.K.-based Capula Investment Management. Dai-ichi is looking for further opportunities to invest in alternative fund management firms and can start looking at deals worth several billion dollars in the asset management industry once it completes current efforts to boost capital efficiency, Kikuta said.
"We still lack scale in asset management,' he said.
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