Markets

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

Japanese investors had a torrid time in the lead up to the French elections, offloading about 3 trillion yen ($26.5 billion) of French government bonds. But with net buying of the overseas notes in seven of the past eight weeks, according to Japan Ministry of Finance data, could they be returning?

The recent jump in 10-year European bond yields provides Japanese investors -- if they were to hedge their currency exposure back into yen -- with a far better return versus similar domestic notes, or JGBs.

Over the course of 2016, life insurers and banks from Asia's second-biggest economy gained confidence in the Bunds-plus strategy of investing in French government bonds, also referred to as OATs. France is inextricably entwined with Germany, the theory goes, but OATs offer a pick-up in yield while also being a liquid market.

However as the French presidential election heated up and the populist threat of Marine Le Pen's National Front grew, Japanese holdings of OATs tumbled. Consequently, "Le Spread" between French and German bonds rose sharply.

That spread has now reverted to more normal levels, but it doesn't take into account the extra advantages that money managers receive from swapping euro-based assets back into yen.

With JGB yields below zero out to eight years and only rising to seven basis points at the 10-year mark, Japanese investors are driven to look elsewhere for any yield enhancement.

French Attraction
What French 10-year bonds yield when swapped into Japanese yen
Source: Bloomberg
Formula calculation: French 10-year bond yield minus three-month Euribor plus three-month yen Libor. (Yen basis swap - Euro basis swap)/100.

The interest-rate gap between money market rates in euros versus those in yen (cross-currency basis swap) offers a pick-up of almost 30 basis points on a euro security swapped into the Japanese currency. While that spread has remained stable recently, the move higher in European bond yields makes such notes that much more attractive.

At the start of a new quarter and with additional firepower, now could be an opportune time for Japanese investors to put European bonds back on their radars.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Updates bond yields sixth paragraph. An earlier version of this column was corrected to amend currency descriptions in first chart.)

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net