China’s Japan Bond Purchases May Resume After Record Run in 2016

  • Swap premium probably explained the past attraction of JGBs
  • Some China JGB purchases likely channeled through Europe

After gorging on a record amount of Japanese bonds in 2015 and the first half of last year, China took a breather. That may end as a widening interest-rate gap starts burnishing the allure of its neighbor’s securities once again.

The Bank of Japan’s mega stimulus in recent years made it attractive for foreigners buying Japanese government bonds when hedging the exposure through the swaps market. Dollar holders benefited from the discount offered to borrow yen. China, one of the largest holders of dollars outside the U.S., was a big buyer of the bonds, BOJ data show.

Purchases tailed off in mid-2016, monthly data show. That was when Japan’s central bank began signaling that longer-term JGB yields had gone too low, and officials increasingly began to question the sustainability of the BOJ’s unprecedented scale of balance-sheet expansion. 

“It’s pretty much an FX-income strategy, rather than China trying to have more exposure to the Japanese yen,” said Yunosuke Ikeda, head of Japan foreign-exchange research at Nomura Holdings Inc. in Tokyo.

China’s State Administration of Foreign Exchange, which oversees the investment of the nation’s reserves stockpile, didn’t immediately respond to faxed questions on Chinese purchase patterns of Japan’s debt. 

With the prospect the Federal Reserve will keep raising U.S. rates this year, the attraction to a potential dollar-based buyer like China may be enhanced by the increasing divergence between the BOJ and Fed. Governor Haruhiko Kuroda has signaled he and his BOJ board colleagues are prepared to maintain their stimulus, which is now focused on keeping 10-year yields around zero percent. The key overnight rate is targeted at negative 0.1 percent.

“There’s little chance that Japan’s negative-rate policy will be abandoned -- the direction of monetary policies will diverge in 2017,” said Naoya Oshikubo, a rates strategist at Barclays Plc in Tokyo. “I expect that China may basically head to net buying of Japanese debt securities in 2017.”

Oshikubo doubted that the buying would return to peak levels, however. Ikeda at Nomura was also skeptical about a resurgence. One dynamic to consider as well is the appetite of Japanese investors to engage in the mirror image of the hedging that dollar-based investors undertake in basis swaps. Last year, as Japanese fixed-income investors left the negative rate world of JGBs and piled into U.S. Treasuries, there was large demand, Ikeda said. 

Japan’s investors have a more hesitant attitude toward Treasuries now -- read about that here.

China’s past purchases have left it as one of the largest foreign holders of Japan’s bonds. The BOJ only reports that data on an annual basis, and 2015 offers the latest figures available.

The large holdings reported for Luxembourg, and to a lesser extent Belgium, reflect their hosting of clearing houses, through which China and other buyers sometimes purchase Japanese debt. The U.K. is also host to financial institutions that transact business of non-residents. All three European countries are also bigger reported holders of U.S. Treasuries than Germany, Europe’s biggest economy.

— With assistance by Yinan Zhao, Masaki Kondo, and Kevin Buckland

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