Yellen-Kuroda Divergence Driving Japanese Bond Investor Exodus

  • Banks, insurers buying foreign debt at fastest pace since '12
  • Spread between two-year JGBs and Treasuries widest since 2010

Japanese banks and insurers are shipping money overseas at the fastest pace since 2012 as global monetary policy diverges.

The nation’s financial institutions bought almost 12 times more mid- to long-term foreign debt in the first 11 months of this year than in all of 2014 as Bank of Japan stimulus kept local yields near record lows. The spread between Japanese and U.S. two-year sovereign yields reached the widest in 5 1/2 years as the Federal Reserve moves toward its first interest-rate increase in almost a decade. The same dynamic also pushed the cost of currency hedging to a four-year high.

The shift is a boon for central bank governor Haruhiko Kuroda’s goal of encouraging investment in riskier assets such as stocks and foreign securities as he tries to free Japan from decades of deflation. He reiterated in a speech Monday that his policies have had the “positive financial effects” of holding down bond yields, encouraging portfolio rebalancing and boosting asset prices. While the BOJ denies it is targeting a weaker yen, outflows have helped the currency decline 2.3 percent versus the dollar this quarter.

Leaving Home

“With yields so low, it’s difficult to expect Japanese investors to return to their home market,” said Katsutoshi Inadome, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities Co. “Major life insurers haven’t been coming back to yen bonds even though dollar-funding costs are rising.”

Japanese investors including financial institutions snapped up a net 11.2 trillion yen ($91 billion) of mid- to long-term foreign debt this year to November, compared with 966.8 billion yen for all of 2014, according to data released Tuesday by the Finance Ministry. The pace of purchases is the fastest over the period since 15.8 trillion yen in 2012.

That’s even as cross-currency basis swaps showed yen holders seeking to borrow dollars were asked to pay the highest premium since November 2011 over Japanese interbank money market rates last month, at 70 basis points. The spread was 53 basis points Wednesday, more than double the average over the past five years.

Low Yields

“It takes time to decipher whether a widening of basis swaps is manageable or not -- and because insurers tend to make investment decisions with a long-term horizon, they can’t easily change direction,” said Yusuke Ikawa, a Tokyo-based strategist at UBS Group AG. “They could return to JGBs at some point, but yields haven’t reached that level where they are convinced they should do so.”

Ten-year JGB yields were at 0.31 percent, the lowest globally after Switzerland. Two-year notes yielded minus 0.035 percent, compared with 0.929 percent in the U.S. -- a gap of about 96 basis points. It was 97 basis points on Dec. 3, a level unseen since April 2010.

The divergence has been driven by growing conviction among traders that the Fed will lift off in December, while the BOJ continues with massive monetary stimulus.

Futures markets show odds at 78 percent for the Federal Open Market Committee to raise borrowing costs on Dec. 16, according to Bloomberg calculations. In testimony before Congress’s Joint Economic Committee on Dec. 3, Chair Janet Yellen signaled the conditions necessary for an interest-rate increase have been met, and she hopes to tighten monetary policy slowly after liftoff.

Managing Risks

Japan’s life insurers are likely to continue moderately accumulating foreign bonds to seek higher returns if the very low bond yields in Japan persist, Fitch Ratings said in a report this month.

“Although the increasing allocation to foreign bonds will provide broader diversification from the concentration on JGBs, currency risks need to be managed effectively given the majority of the life insurance liabilities are still yen-denominated,” according to the report.

Domestic financial institutions bought just 201.9 billion yen of super-long-term JGBs -- the sector where life insurers are most active -- in the 10 months to October, according to data from the Japan Securities Dealers Association. That’s only about 40 percent of what they purchased over the same period last year, and the least since 2007.

“Yields on yen bonds are extremely low, so domestic investors are likely to limit their investment,” said Eiichiro Miura, the Tokyo-based chief fund manager at Nissay Asset Management, which oversees about $71 billion. “Demand for foreign debt will continue amid a hunt for yield, even as the Fed starts raising rates.”

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