Japanization of euro zone bonds?
Fear of many years of stagnation in the major western economies has everyone fretting about a repeat of the “lost decades” that Japan suffered after its banking and real estate bubble burst in the early 1990s. Indeed HSBC economists were recently keen to point out that U.S. per capita growth over the noughties was already actually weaker than either of Japan’s lost decades.
But in a detailed presentation on the impact of two years of soveriegn debt crisis on euro zone government bond holdings, Barclays economist Laurent Fransolet asks whether that market too is turning into the Japanese government bond market — where years of slow growth, zero interest rates, current account surpluses and captive local buyers have depressed borrowing rates for years and turned JGBs into an increasingly domestic market dominated by local banks, pension funds and insurers. Non-residents hold less than 10 percent of JGBs, compared to more than 50 percent for the EGB as a whole, and Japanese banks hold up to 35 percent of their own government bond market.
But is the euro government market heading in that direction after successive crises have seen foreign investors flee many of the peripheral markets of Greece, Portugal, Ireland and even Italy and Spain? Fransolet argues that the seniority of substantial European Central Bank holdings built up in the interim (now about 15 percent of each of the five peripheral markets) may be one reason why these foreign investors will be wary of returning. Meantime, euro zone banks, who have traditionally held a high 20-25 percentage point share of euro government markets, withdrew sharply late last year amid balance sheet repair pressures but have rebuilt holdings again sharply in early 2012 after the ECB’s liquidity injections — particularly in Italy and Spain.
In answer to the longer-term question of whether euro bonds will turn into a more insular market dominated less by interest rate signals than liquidity, regulatory and balance sheet issues, Fransolet is equivocal. On one level they are still very different — state-sector holdings of euro debt are still far from Japan’s, the euro market has clearly fragmented and net new issuance of euro debt is also still way below Japan.
However, the trend is clearly toward a more domestically driven market in the periphery of euro bloc in particular and local banks are becoming bigger players. And, crucially, although foreign investors may not return en masse soon, their impact on those markets via futures and CDS markets and index weightings may still be high.