The Bank of Japan has long invested heavily in purchasing ETFs to hedge against losses from holding bonds, but how the "giant whale" will withdraw has become a problem...
Bloomberg strategist Hideyuki Sano analyzed that while the market is paying attention to the massive amount of bonds held by the Bank of Japan, it has also started to focus on the attitude of the new Bank of Japan Governor, Kazuo Ueda, towards the 48 trillion yen ($364 billion) worth of stocks held by the central bank.
Given that Ueda may begin to implement policy normalization, these stocks held through ETFs have become a sword of Damocles hanging over the market.
Mitsubishi UFJ Morgan Stanley Securities Chief Investment Strategist Norihiko Fujito said that in the six months from September to now, the Bank of Japan's ETF holdings have made a paper profit of 11 trillion yen, which could be used to hedge against bond market losses.
The high dividends from the holdings have also made the Bank of Japan very profitable. According to the Bank of Japan's income report, as of September, its holdings of ETFs exceeded 1 trillion yen, quadrupling compared to the same period five years ago.
The valuation of the Japanese stock market is not high. The Topix index's price-to-earnings ratio is 12.7 times, one standard deviation lower than the average value of the past 10 years, while the S&P 500 index's price-to-earnings ratio is 18.3 times.
Chief Economist Sayuri Kawamura of the Japan Research Institute think tank said:
"ETFs have replaced low-coupon 10-year Japanese government bonds (JGBs) as the mainstay of the Bank of Japan's profits. But this only works when stock prices are stable; if stock prices plummet, the Bank of Japan may suffer huge losses."
Bank of Japan Deputy Governor Shinichi Uchida said in March that if the 10-year bond yield rises from the current 0.46% to 2%, the Bank of Japan will incur a paper loss of 50 trillion yen.
According to the latest report, the Bank of Japan's holdings of government bonds have a paper loss of 8.75 billion yen.At the beginning of this year, Japan's inflation rate reached 4.2%, a 41-year high, which is closely related to the Bank of Japan, which holds more than half of the sovereign bonds.
The Bank of Japan's mission is not to maximize profits, and it is not the only central bank affected by its investment portfolio. However, many analysts believe that the Bank of Japan wants to avoid huge losses, as this may undermine confidence, lead to public criticism of its policies, and ultimately limit the flexibility of the bank.
Hiromichi Shirakawa, a former Bank of Japan official and Chief Japan Economist at Credit Suisse, said:
"At present, the Bank of Japan needs to take its investment portfolio seriously and manage it cautiously. The importance of the Bank of Japan's holdings is self-evident."
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