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The Bank of Japan’s recent relaxation of its cap on bond yields is expected to boost returns on the country’s debt. Some investors predict a surge in Japanese investment flows, which is being referred to as a “great repatriation”.
This shift in policy comes at a time when many Japanese investors are finding overseas debt less attractive due to the high cost of hedging against currency fluctuations. Japanese insurers and other major investors typically hedge their currency exposure when buying foreign bonds. However, rising interest rates in other developed economies have significantly increased the cost of hedging, making Japan’s low-yielding bond market appear relatively more enticing.
Data from Apollo shows that the currency-hedged yield on a 10-year Treasury fell below the equivalent Japanese bond yield last year, creating a significant disparity between the two markets. As a result, Japanese investors have favored purchasing Japanese government bonds over foreign alternatives.
Mohit Kumar, Managing Director at Jefferies, explains, “It hasn’t made sense for Japanese investors to own Treasuries and [German] Bunds, they would rather buy Japanese government bonds – which is what everyone was doing.”
Japanese investors have traditionally held significant amounts of US and European bonds due to favorable currency exchange rates and higher returns. However, this trend has reversed in the past 18 months, with Japanese investors becoming net sellers of foreign assets. Despite the low borrowing costs in Japan’s domestic bond market, the Bank of Japan’s recent move towards ending its ultra-loose monetary policy has further boosted the appeal of the domestic market.
According to Michael Metcalfe, Head of Macro Strategy at State Street Global Markets, the increase in global yields in response to Japan’s yield curve control adjustment has raised concerns that local investors will reduce their holdings of US and European bonds and increase their investments in Japanese government bonds.
Investors also anticipate that the relatively strong Japanese economy and the diminishing threat of deflation will attract more investors back to Japan, including the high-performing Tokyo stock market. Luca Paolini, Chief Strategist at Pictet, believes that the “great repatriation” of Japanese assets is just beginning and will lead to a re-evaluation of Japanese equities.
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