Lombard: GPIF’s overweight in Japanese bonds may trigger global unwind of carry trades, Banco Internacional de España: GPIF may sell $62 billion of US Treasury bonds!

The asset allocation trends of Japan’s largest global pension fund, GPIF, are becoming a new source of systemic risk in the global bond and foreign exchange markets.

TS Lombard and Banco Santander have recently released reports noting that GPIF is accelerating, or about to accelerate, its reallocation back into Japanese domestic bonds, and the scale of this move could have a substantial impact on US and European government bond yields.

According to estimates by Banco Santander, even without triggering a formal asset allocation review, GPIF could reduce up to $62 billion of US Treasuries under the current policy framework.

TS Lombard further points out that this structural capital reflow will push USD/JPY below 150, indicating a fair value range of 130 to 140, and that the risk of passive deleveraging in global carry trades has yet to be fully priced in by the market.

At present, Japan’s Minister of Health, Labour and Welfare, Kenichiro Ueno, has confirmed that officials are studying the need for a review of GPIF’s asset allocation, but no formal decision has been made. Meanwhile, GPIF’s allocation to domestic bonds had risen to 27% by the end of March, exceeding the 25% benchmark target, suggesting there is still room to increase allocations by 4% without changing current policies.

Currently, the market has not fully priced in this potential pivot, and speculative short positions on the yen remain elevated.

Over the past two years, the US-Japan 10-year government bond yield spread has continuously narrowed, yet USD/JPY has remained near historic highs, creating a rare prolonged divergence.

TS Lombard believes that the yen is beginning to move in sync with interest rate differentials; if this convergence trend continues, downward pressure on the exchange rate will persist.

The key factor supporting yen weakness has never been the yield differential itself, but Japan’s ongoing large-scale capital outflows. Japan’s massive current account surplus has long been offset by outflows of portfolio capital and carry trades.

Even as domestic asset yields have risen over the past two years, Japanese investors continued to buy foreign assets. Now this behavior is reversing—capital is flowing back into Japan, making the return of funds, rather than official intervention, the structural driver of a stronger yen.

The yield on Japan’s 10-year government bonds reached 3% last week for the first time since 1996, driven by inflationary pressure, concerns over fiscal spending, and market expectations of a faster pace of rate hikes by the Bank of Japan.

TS Lombard expects the Bank of Japan to resume quarterly rate hikes starting from January 2027, with the terminal rate reaching 2% in Q4 2027. The direction of yield differential narrowing is now established.

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

Any marginal change in GPIF’s allocation behavior is sufficient to have a perceptible impact on the global fixed income markets.

As of the end of March this year, GPIF’s domestic bond allocation had risen to 27%, above the 25% benchmark target. Under current policy, the fund allows fluctuations within 5 percentage points above or below the benchmark, meaning up to a 31% maximum allocation, leaving about 4 percentage points of further increase possible.

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

The team led by Antonio Villarroya, Global Head of Fixed Income, FX, and Commodities Strategy at Banco Santander, wrote in a client note: "Given the flexibility granted by the strategic allocation range, GPIF could begin to reduce its foreign bond holdings over the coming months without waiting for a formal strategic asset review."

The bank’s model scenario assumes that GPIF reduces its allocation to foreign bonds from current levels to 20% of its portfolio—still within current policy limits—so the potential scale of US Treasury sales could reach $62 billion, with the risk concentrated in US Treasuries.

The Villarroya team added that if the Bank of Japan successfully strengthens the yen through consecutive rate hikes, the path to reducing these holdings will become even more likely.

The logic of carry trades is built on low volatility: as long as the yen exchange rate remains stable, borrowing yen and allocating to high-yield assets allows spread earnings to accumulate. Once yen volatility rises, risk-adjusted returns on shorting the yen deteriorate rapidly, forcing a contraction of leveraged positions.

TS Lombard notes that official interventions are only a catalyst; volatility is the key variable that turns intervention into broader position unwinding.

TS Lombard’s relative price and rate models show that the fair value for USD/JPY lies between 130 and 140. The current level near 150 is not supported by fundamentals and is more likely just a threshold for a new regime.

Currently, the market has yet to position for a comprehensive repricing of the yen—speculative positions remain predominantly short yen. Should USD/JPY decisively break below 150, forced short covering could become the main driver in the next phase.

TS Lombard warns that the impact of yen appreciation extends beyond the exchange rate itself, with the potential to spread to global assets.

If USD/JPY falls in a disorderly fashion, it could force cross-asset carry positions to deleverage in tandem, turning the yen rebound into an even larger volatility event—a scenario intrinsically similar to the global equity turmoil triggered by the yen’s surge in August 2024.

TS Lombard believes that after the recent dip in VIX, going long equity volatility is an effective tool to hedge this tail risk, and warns that if GPIF—the “super tanker”—continues to accelerate, global volatility might not remain dormant.