No Place Like Home for Japan Insurers as Swaps Erode U.S. Appeal

Updated on
  • Insurers will announce asset allocation strategy this month
  • Treasury yield adjusted for hedging near lowest since April

Japan’s life insurers are finding there’s no place like their home bond market, as a surge in the cost of swaps reduces the allure of Treasuries yielding six times more than local debt.

Cross-currency basis swaps show yen holders seeking to borrow dollars were asked to pay the highest premium since December 2011 over Japanese interbank money market rates this month. Ten-year U.S. notes yield 1.79 percent after accounting for hedging costs, near the lowest level since April. Similar Japanese government bonds yield 0.325 percent.

A two-month rally in the yen and a rebound in JGBs since June are improving the appeal of domestic debt as the dollar heads lower amid speculation the U.S. economy is too fragile for the Federal Reserve to raise interest rates this year. Japan’s life insurers, the biggest holders of the nation’s government bonds after the central bank, were the only domestic financial institutions to increase JGB holdings during the second quarter, according to the Bank of Japan. They will announce asset allocation plans this month. 

“With the yen’s decline slowing, I think insurers have become less bullish on unhedged foreign bonds while hedging costs aren’t necessarily favorable for Japanese investors,” said Genji Tsukatani, a fund manager in Tokyo at JPMorgan Asset Management Inc., which has about $1.8 trillion in assets. “Since their focus remains primarily on super-long bonds, they could slightly boost holdings of the debt in light of the global market environment.”

Japan’s major life insurers will get a chance to stock up on fresh 20-year sovereign notes at an auction of 1.2 trillion yen ($10 billion) of the debt on Tuesday as they enter the second half of their fiscal year this month. Nippon Life Insurance Co., Dai-ichi Life Insurance Co., Meiji Yasuda Life Insurance Co. and Sumitomo Life Insurance Co. said in April that they would cap JGB purchases and boost foreign holdings after the Bank of Japan’s unprecedented bond buying pummeled the yen and dragged down 10-year yields to a record 0.195 percent in January.

“The maturity isn’t too expensive to deter investors,” said Yusuke Ikawa, a UBS Group AG strategist in Tokyo, referring to 20-year debt. “Hedged foreign bonds are not paying off for life insurers and this is favorable for JGBs and could lead to curve flattening.”

Volatility Risk

Bets that slowing global economic growth and falling stocks will convince the Fed to delay raising rates have revived demand for the yen as a haven, helping it to rebound 5.3 percent since touching a 13-year low of 125.86 on June 5. The yen was little changed at 119.45 as of 1:55 p.m. in Tokyo on Monday. Cross-currency basis swaps show Japanese investors needed to pay a 53 basis point premium over yen interbank rates to obtain dollars on Oct. 6, matching the highest cost in almost four years.

While the prospects for Japanese bonds may appear to be improving, the market’s potential fluctuations should give caution to bullish investors as the BOJ decides whether to expand stimulus, according to Satoshi Okumoto, the chief executive officer and president at Fukoku Capital Management, which oversees the equivalent of $17 billion.

“JGBs are not a safe asset in light of price volatility risks,” said Okumoto. “The BOJ’s buying will not last forever and I think further easing on Oct. 30 has become less probable. Markets are entering a period where investors need to think of price volatility risks.”

Governor Haruhiko Kuroda and his colleagues on Oct. 7 kept unchanged the central bank’s policy of buying as much as 12 trillion yen in JGBs a month to increase the monetary base at an annual pace of 80 trillion yen. A Bloomberg survey taken Sept. 29-Oct. 2 showed 15 of 36 economists forecast it will expand stimulus on Oct. 30. Poor data for exports and industrial output have the potential to force the BOJ into bolstering easing this month, said Hideo Hayakawa, a former chief economist for the bank.

Flatter Curve

Speculation that the BOJ will boost its purchases of longer-dated JGBs could accelerate a flattening of the yield curve, JPMorgan’s Tsukatani said. The difference in five- and 30-year JGBs narrowed to 127 basis points last week, the smallest gap in more than five months.

Japanese government debt with at least 10 years to maturity have returned 5.7 percent over the past 12 months, beating the 4.5 percent return for equivalent U.S. Treasuries excluding currency fluctuations, according to Bloomberg bond indexes.

“Rising funding costs are making it less attractive to seek yields from foreign bonds,” said Akito Fukunaga, the chief Japan interest-rate strategist at Barclays Plc in Tokyo. “Between choosing unhedged foreign bonds and low-yielding -- but low risk -- Japanese bonds, investors are making a passive choice of buying JGBs on bets the curve will flatten.”