Lombard: GPIF's overweight position in Japanese bonds may trigger global carry trade unwinding; Banco Santander: GPIF may sell $62 billion in US Treasuries!

The asset allocation trends of Japan’s largest global pension fund, GPIF, are emerging as a new source of systemic risk in the world bond and forex markets.

TS Lombard and Banco Santander have each recently released reports indicating that GPIF is either currently accelerating or about to accelerate the repatriation of funds to domestic Japanese bonds, on a scale that could substantially impact US and European government bond yields.

According to estimates by Banco Santander, even without triggering an official asset allocation review, GPIF could reduce its holdings of US Treasuries by up to $62 billion within the current policy framework.

TS Lombard further noted that this structural capital repatriation will push USD/JPY below 150, with a fair value range between 130 and 140, while the risk of passive deleveraging in global carry trades has not yet been fully priced in by the markets.

Currently, Japanese Minister of Health, Labour and Welfare Kenichiro Ueno has confirmed that officials are studying whether there is a need to review GPIF's asset allocation, but no official decision has yet been made. Meanwhile, as of the end of March, GPIF's domestic bond allocation has risen to 27%, above the 25% benchmark target, leaving room for an additional 4% increase without changing current policy.

At present, the market has not fully priced in this potential shift, and speculative short yen positions remain high.

Over the past two years, the 10-year US-Japan government bond yield spread has continued to narrow, yet USD/JPY has remained near historic highs, resulting in an unusual prolonged divergence.

TS Lombard believes that the yen is once again moving in tandem with interest rate differentials, and if this convergence trend continues, downward pressure on the exchange rate will persist.

The key factor supporting a weak yen has never been the interest rate spread itself, but rather the continued large-scale capital outflows from Japan. Japan's massive current account surplus has long been overwhelmed by portfolio capital outflows and carry trades.

Over the past two years, Japanese investors have continued to buy overseas assets, even as domestic asset yields have risen. This behavior is now reversing—funds are returning to Japan, making the repatriation itself, rather than official intervention, a structural driver for yen strength.

Last week, the yield on Japan's 10-year government bonds touched 3%, the highest since 1996, driven by inflationary pressures, concerns over fiscal spending, and market expectations for faster rate hikes by the Bank of Japan.

TS Lombard forecasts that the Bank of Japan will resume quarterly rate hikes from January 2027, with the terminal rate reaching 2% in the fourth quarter of 2027. The direction of narrowing yield differentials has already been established.

GPIF currently manages assets of about $2 trillion, making it the largest pension fund in the world and one of the largest foreign holders of US Treasuries—according to US Treasury data, Japan’s total holdings of US government debt stand at $1.1 trillion.

Any marginal change in GPIF's allocation behavior is sufficient to create tangible shocks in global fixed income markets.

As of the end of March this year, GPIF’s domestic bond allocation had risen to 27%, higher than the 25% benchmark target. Under current policy, the fund allows for a 5 percentage-point swing above or below the benchmark, meaning the maximum allocation is 31%, with roughly 4 percentage points of headroom remaining.

TS Lombard points out that this shift may just be beginning.

A team led by Antonio Villarroya, Banco Santander’s Global Head of Fixed Income, FX, and Commodity Strategy, wrote in a client note: “Given the flexibility provided by the strategic allocation band, GPIF could begin reducing foreign bond holdings in the coming months without waiting for an official strategic asset allocation review.”

The bank’s model scenario assumes that GPIF lowers its foreign debt allocation from current levels to 20% of its portfolio—still within the allowed policy range—resulting in a potential reduction of up to $62 billion in US Treasuries, with the selloff risk concentrated in US government bonds.

The Villarroya team adds that, if the Bank of Japan successfully strengthens the yen through consecutive rate hikes, the above reduction path is even more likely to be adopted.

The logic of carry trades depends on low volatility: as long as the yen’s exchange rate is stable, the yield spread earned by borrowing yen and allocating it to high-yield assets can continue to accrue. Once yen volatility rises, the risk-adjusted return on short yen positions rapidly deteriorates and leveraged positions are forced to contract.

TS Lombard points out that official intervention is only a catalyst; volatility is the key variable that transforms intervention into broader position unwinding.

TS Lombard’s relative price and interest rate model indicates USD/JPY’s fair value is between 130 and 140; the current price near 150 is not supported by fundamentals, but is more likely a threshold to a new regime.

The market has yet to fully prepare for a comprehensive yen repricing—speculative positions remain heavily short yen. Once USD/JPY decisively breaks below 150, forced short covering may become the main driver in the next stage.

TS Lombard points out that the impact of yen appreciation goes beyond the exchange rate itself and has the potential to spill over into global assets.

If USD/JPY experiences a disorderly decline, it could force cross-asset carry trades into rapid deleveraging, escalating the yen rebound into a broader volatility event—with an inherent similarity to the global stock market turbulence triggered by the surge in the yen in August 2024.

TS Lombard believes that, after the recent decline in the VIX, going long equity volatility is an effective tool to hedge the tail risk described above, and warns that if the “supertanker” GPIF continues to accelerate, global volatility may not remain dormant.