Global Love for Japan Bonds Relies on Brexit and Other Bad News

  • Overseas investors’ net buying of JGBs in a record run: JSDA
  • Foreign investors account for about 10th of market as of March

The surge in foreign ownership of Japanese government bonds to a record high this year could come back to haunt the world’s second-biggest debt market.

Bank of America Merrill Lynch says that a global event that leads to a rebound in sovereign note yields worldwide, such as a decision by Britain to stay in the European Union in the June 23 referendum, could be all it takes to trigger an unwinding of 23 consecutive months of net buying of JGBs by overseas investors. Totan Research Co. says any policy shift that affects the cost of swapping dollars into yen for fund managers could also “trigger shocks” to the market.

The following charts show the rise in foreign ownership of Japanese sovereign notes and its relationship to global events and currency markets:

Chart 1: Yields on 10-year bonds in Japan, Germany and U.K. hit record lows as the chance of Britain leaving the EU surged to a record high. “Foreign investors being net JGB buyers for nearly two years exposes them to the biggest potential for selling,” said Shuichi Ohsaki, chief rates strategist at Bank of America Merrill Lynch in Tokyo. “As prices rise, they may be thinking of unloading JGB holdings, which could come in one go. Overseas spikes in yields or the U.K. remaining in the EU could be a trigger for some selling.” Japan’s benchmark yield was minus 0.145 percent on Tuesday morning in Tokyo.

Chart 2: Cross-currency basis swaps show falling costs to borrow yen for five years. “Since overseas buying is largely due to the cheap yen, a shift in Japan’s current policy risks trigger shocks to the JGB market,” said Izuru Kato, president of Totan Research in Tokyo. “A prolonged period of negative yields erodes government incentives for fiscal consolidation. Foreign investors could find reasons to trigger selling at some point.”

Chart 3: Foreigners bought a net 1.7 trillion yen ($16 billion) of mid-to-long term JGBs in May after purchases reached a record high in April, Japan Securities Dealers Association data show. They have been net buyers for a 23rd month, the longest since JSDA began compiling data in 2004.

Chart 4: Foreign ownership rose to 110 trillion yen of JGBs at the end of March, making up a 10th of the market, according to Bank of Japan data. Meanwhile, Japanese banks and insurers are getting pushed into ever longer maturities, or into overseas markets, as the BOJ easing sends yields below zero on debt due in up to a decade. “For the long term, if they sense risk, foreigners with a 10 percent ownership will pull the trigger,” said Nana Otsuki, the chief analyst at Monex Group Inc., a Tokyo-based online securities firm. “If that provokes Japanese investors, we could see rapid selling.”

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