Global Funds Add Japan Bonds at Triple Pace of Insurers on Swap

Foreign investors are taking advantage of attractive swap rates to load up on Japanese government bonds, adding three times more than local insurers.

Overseas investors held a record 45.4 trillion yen ($374 billion) in JGBs, excluding bills, on Dec. 31, up 10 percent in the quarter, the Bank of Japan’s flow of funds report released Wednesday showed. They purchased a net 15 trillion yen of interest-bearing domestic debt in the 12 months to January, versus 5.39 trillion yen for local insurers, based on Japan Securities Dealers Association data.

Central bank stimulus including the European Central Bank’s 1.1 trillion-euro ($1.2 billion) bond-buying plan, is driving yields lower around the world as Federal Reserve plans to raise interest rates provide opportunities to profit on currencies. While Japan’s benchmark 10-year yield is at 0.365 percent, swapping into U.S. dollars would offer payments equivalent to 65 basis points more than yields on Treasuries, Bloomberg-compiled data show. Similar payments for bunds would deliver a premium of about 24 basis points.

“JGBs are relatively more stable than European or U.S. bonds and dollar-based investors have an advantage using basis swaps,” said Toru Suehiro, a market economist at Mizuho Securities Co. in Tokyo. “Foreign funds are expected to continue to flow into JGBs, making it difficult for yields to rise.”

Weak Yen

Overseas buying of medium-to-long-term JGBs for the 11 months to February hit a record at 9.93 trillion yen, surpassing the previous record for the same period in fiscal 2006 of 9.53 trillion yen, according to Ministry of Finance data.

“One factor behind foreign buying of JGBs is simply that the weak yen gives a sense of discount,” said Kazuto Doi, a Tokyo-based fund manager at Western Asset Management, which managed $466 billion at the end of 2014. “Another is that using basis swaps to purchase JGBs still gives advantages.”

The yen tumbled to a 7 1/2-year low of 122.03 to the greenback last week and traded at 121.32 at 5:02 p.m. in Tokyo on Wednesday.

Overseas investors prefer longer maturities as yield spreads are relatively wide in Japan, Doi said.

Wider Spread

The spread between 10-year and 30-year JGBs was at 101 basis points. That compares with the 56 basis points for Treasuries with the equivalent maturities and 44 basis points for those of German bunds.

“Foreigners own shorter-dated debts generally but some may be eyeing Japanese super-long JGBs, with global downward pressures on yields fueling speculation about the Japanese spread tightening,” Doi said.

Investors abroad held 50.1 trillion yen in Japanese Treasury bills at the end of December, up 2.7 percent from three months earlier, the BOJ report showed.

Benchmark 10-year bond yields reached a record low of 0.195 percent in January, as the BOJ buys as much as 12 trillion yen of local government debt in a record stimulus.

Japanese bonds may also offer relatively better income than their U.S. peers as the BOJ, along with the ECB, remains distant from exiting the current stimulus while the Fed moves toward tightening, said Makoto Yamashita, strategist for Japanese interest rates at Deutsche Securities Inc.

The central bank this week kept a pledge to expand the monetary base at an annual pace of 80 trillion yen, as forecast by all 34 economists in a Bloomberg News survey. Twenty-three of 34 economists in the Bloomberg survey expect the BOJ to expand stimulus by the end of October.

“Investors may want to return to U.S. Treasuries after the Fed acts on rate increase and yields rise to sufficient levels,” Yamashita said. “It is a transitional period now. From a diversification point of view, Japanese yields don’t look particularly low relative to past levels with this global trend of low yields.”

Before it's here, it's on the Bloomberg Terminal.