The Formosa bond ripple effect: How Taiwan's financial shifts could stir U.S. mortgage rates
Shreeaa Rathi | TIMESOFINDIA.COM | May 06, 2025, 21:37 IST
( Image credit : TIL Creatives )
Market watchers are closely monitoring Formosa bonds, which serve as a financial bridge between Taiwan and the U.S. Fluctuations in these bonds could influence mortgage rates in the States. The role of Taiwanese insurers in this dynamic is pivotal. Meanwhile, JPMorgan and Barclays present contrasting forecasts regarding the repercussions. Anticipated volatility in the U.S.
As the Taiwanese dollar regains its footing, global financial analysts are taking a closer look at a lesser-known but powerful financial link between Taiwan and the United States—Formosa bonds. These bonds, once instrumental in influencing U.S. interest rate volatility, are again under scrutiny as market dynamics shift.
Formosa bonds are debt securities issued in Taiwan by foreign entities, denominated in U.S. dollars. These instruments gained popularity with Taiwanese life insurers who sought exposure to dollar assets, especially during periods of low U.S. interest rates. As of now, about $300 billion worth of these bonds exist, with roughly half being "callable"—meaning issuers can redeem them early. This feature, while seemingly niche, once helped suppress U.S. mortgage rates by dampening interest rate volatility.
However, the landscape began to change when the U.S. Federal Reserve started aggressively hiking rates in 2022. Formosa bond issuance plummeted, and analysts are now wondering whether recent turbulence could ripple through U.S. markets. JPMorgan has warned that Taiwanese life insurers may find themselves vulnerable to the appreciating Taiwanese dollar, potentially triggering broader consequences.
The worry centers on whether these insurers will unwind their positions in callable bonds, sparking a rush to buy back exposure to long-term volatility—referred to as "vega" in market parlance. But Barclays analysts believe this scenario is unlikely. In their view, currency hedging would be the immediate response, not a fire sale of exotic instruments. Additionally, the exposure to foreign exchange risk from these callable structures is relatively small compared to the insurers' broader currency holdings.
Still, there could be a more subtle, long-term impact. As the likelihood of another boom in Formosa bonds fades, the U.S. bond market may experience a shift in how volatility is priced. The absence of a fresh supply of callable Formosa bonds could lead to higher interest rate volatility, nudging up U.S. mortgage costs in the process.
For institutional investors who specialize in long-dated volatility, this shift could reduce the risk of a sudden supply-driven collapse in volatility prices. As one Barclays note puts it, the chances of a “volatility shock” from a new wave of callable issuance are slim—especially in a high-rate environment.
Furthermore, this episode might make Taiwanese insurers more cautious about investing in illiquid U.S. dollar assets like long-dated callable bonds. With evolving U.S. trade policies and a potential decline in global demand for dollar-denominated assets, foreign appetite for such instruments could shrink even more.
There’s also an impact on how volatility “skew” is perceived in the market. Currently, long-dated options tend to price higher volatility for large upward rate moves than for declines, in part because traders expect a return of volatility supply when rates fall. But with the Formosa pipeline likely throttled, this skew may flatten, suggesting a more symmetric outlook for future interest rate swings.
In short, while the immediate risks may be muted, the aftershocks from Taiwan’s evolving financial strategies are likely to be felt across the Pacific. As the world watches Taiwan’s insurers recalibrate, the U.S. market—particularly its mortgage and volatility sectors—could see lasting changes in how it prices risk.
How do you think the changing global bond dynamics could reshape American financial markets long-term?
Formosa bonds are debt securities issued in Taiwan by foreign entities, denominated in U.S. dollars. These instruments gained popularity with Taiwanese life insurers who sought exposure to dollar assets, especially during periods of low U.S. interest rates. As of now, about $300 billion worth of these bonds exist, with roughly half being "callable"—meaning issuers can redeem them early. This feature, while seemingly niche, once helped suppress U.S. mortgage rates by dampening interest rate volatility.
However, the landscape began to change when the U.S. Federal Reserve started aggressively hiking rates in 2022. Formosa bond issuance plummeted, and analysts are now wondering whether recent turbulence could ripple through U.S. markets. JPMorgan has warned that Taiwanese life insurers may find themselves vulnerable to the appreciating Taiwanese dollar, potentially triggering broader consequences.
The worry centers on whether these insurers will unwind their positions in callable bonds, sparking a rush to buy back exposure to long-term volatility—referred to as "vega" in market parlance. But Barclays analysts believe this scenario is unlikely. In their view, currency hedging would be the immediate response, not a fire sale of exotic instruments. Additionally, the exposure to foreign exchange risk from these callable structures is relatively small compared to the insurers' broader currency holdings.
Still, there could be a more subtle, long-term impact. As the likelihood of another boom in Formosa bonds fades, the U.S. bond market may experience a shift in how volatility is priced. The absence of a fresh supply of callable Formosa bonds could lead to higher interest rate volatility, nudging up U.S. mortgage costs in the process.
For institutional investors who specialize in long-dated volatility, this shift could reduce the risk of a sudden supply-driven collapse in volatility prices. As one Barclays note puts it, the chances of a “volatility shock” from a new wave of callable issuance are slim—especially in a high-rate environment.
Furthermore, this episode might make Taiwanese insurers more cautious about investing in illiquid U.S. dollar assets like long-dated callable bonds. With evolving U.S. trade policies and a potential decline in global demand for dollar-denominated assets, foreign appetite for such instruments could shrink even more.
There’s also an impact on how volatility “skew” is perceived in the market. Currently, long-dated options tend to price higher volatility for large upward rate moves than for declines, in part because traders expect a return of volatility supply when rates fall. But with the Formosa pipeline likely throttled, this skew may flatten, suggesting a more symmetric outlook for future interest rate swings.
In short, while the immediate risks may be muted, the aftershocks from Taiwan’s evolving financial strategies are likely to be felt across the Pacific. As the world watches Taiwan’s insurers recalibrate, the U.S. market—particularly its mortgage and volatility sectors—could see lasting changes in how it prices risk.
How do you think the changing global bond dynamics could reshape American financial markets long-term?