Japanese traders have piled into overseas debt this yr — however analysts have warned that the revival in demand from one of many cornerstones of the US Treasury market is unlikely to final.
Information from Japan’s ministry of finance reported this week confirmed that traders purchased ¥4.1tn ($30bn) of overseas debt in February, the biggest complete since September 2021. That follows web shopping for of ¥1.1tn in January, and marks a pause within the dramatic promoting of overseas debt in 2022.
The large rise in yields over the previous yr in markets exterior Japan is theoretically a giant draw for the nation’s banks, insurers and pension funds, who face rock-bottom returns at residence. Nonetheless, the excessive price of hedging overseas bond holdings in opposition to swings within the yen trade charge — which most Japanese traders choose to do — wipes out these further returns and was more likely to imply the present shopping for spree is shortlived, analysts mentioned.
“The price of hedging is already prohibitive and with present expectations concerning the [US Federal Reserve’s] path, is about to turn out to be extra prohibitive,” mentioned Brad Setser, a senior fellow on the Council on Overseas Relations. “You’re not going to get the sustained demand from Japan that you just bought a number of years in the past.”
Japan has been the largest overseas proprietor of US Treasuries for years, as ultra-dovish financial coverage domestically has pushed traders exterior the nation’s borders looking for returns. Japanese traders additionally maintain substantial portions of eurozone authorities debt, significantly French bonds.
Nonetheless, they dumped massive portions of overseas bonds — of which US debt varieties a sizeable proportion — throughout final yr’s historic world fixed-income rout.
Steep rate of interest rises from the Fed and different huge central banks pushed the yen to a 32-year low in October, and raised the associated fee for Japanese traders of hedging in opposition to forex strikes, which relies upon largely on the speed hole between Japan and elsewhere. Whereas the yen rose on the finish of final yr, it has weakened 4.3 per cent up to now in 2023.
The price could possibly be set to extend additional after Fed chair Jay Powell mentioned this week that the energy of US financial information could result in the central financial institution re-accelerating its efforts to elevate borrowing prices, having slowed charge rises earlier this yr. The European Central Financial institution can be anticipated to proceed to elevate charges this yr following a run of robust financial information.
Japanese shopping for of overseas bonds “in the end comes all the way down to the hedging prices, which is aligned with the fed funds charge. The price of funding will dictate overseas flows,” mentioned George Goncalves, head of US macro technique at MUFG. “The month-to-month or weekly flows will not be all the time going to be clean and logical and mirror the hedging prices. However you will notice these developments over the long term.”
A number of the shopping for in latest weeks could also be from Japanese establishments which have extra capability for making unhedged bets, equivalent to pension funds. After the large sell-off final yr, some institutional traders could also be very underweight overseas debt, so “there’s capability to purchase unhedged in the meanwhile”, mentioned Edward Al-Hussainy, senior forex and charges analyst at Columbia Threadneedle.
Nonetheless the riskiness of unhedged holdings of dollar-denominated debt, which may tumble in worth if the yen rebounds in opposition to the US forex, is more likely to restrict the scope for additional demand.
A potential sea change in Japanese financial coverage may ultimately assist to carry hedging prices down. Although rates of interest stay under zero, the reign of Financial institution of Japan governor Haruhiko Kuroda — the architect of the nation’s years of ultra-loose coverage — will finish after the central financial institution’s assembly on Friday.
His successor, Kazuo Ueda, has hinted that he could calm down and even ditch the BoJ’s coverage of pinning 10-year bond yields near zero, a transfer that some traders would see as a prelude to eventual rises in rates of interest.
However tighter financial coverage in Japan may undermine traders’ rationale for abroad bonds within the first place.
“If the extent of yields in Japan begins to go up, immediately that may make Japanese yield ranges extra enticing, which could run the danger of Japanese traders asking why they’re investing overseas,” mentioned Torsten Slok, chief economist at Apollo International Administration. “That could be a main threat to worldwide fixed-income markets.”
