BOJ's Refusal to Budge May Revive Japanese Fund Flow Abroad

  • Low U.S. inflation, steady European politics attract investors
  • Dai-ichi Life may raise exposure to Europe when spreads widen

BOJ Delays Timing for Reaching 2% Inflation Target

As the Bank of Japan digs in its heels to maintain an ultra-loose monetary stance, yield-hungry Japanese investors are looking abroad again, having shunned U.S. and European debt markets early this year.

The BOJ pledged Thursday to maintain its monetary stimulus program, including keeping the 10-year yield around zero percent, as it delayed reaching an inflation goal by a year. Meanwhile, subdued U.S. consumer price growth suggests the Federal Reserve will be gradual in its rate increases, easing concerns over sudden spikes in Treasury yields that led to losses for Japanese investors last year.

"Japanese investors are expected to continue directing funds into foreign bonds, including the U.S. and Europe, attracted by the yields given the zero-interest rates in Japan," said Toshifumi Sugimoto, chief investment officer at Tokyo-based Capital Asset Management which oversees about 25 billion yen ($223 million). "U.S. inflation is well-controlled with consumption and wages staying low, which is another positive factor to buy U.S. bonds."

After months of shunning Treasuries on concern President Donald Trump’s stimulus plans may fuel inflation, Japanese appetite for U.S. debt returned in May when his failed health-care reform bill and allegations of Russian interference in the November elections, cast doubts over the leader’s ability to focus on the economy. 

That same month, Japanese interest for French and German debt also resurfaced as Emmanuel Macron’s victory at the French presidential election allayed concerns of a widening global protectionist stance. This led Japanese investors to turn net buyers of overall long-term foreign debt in May for the first time since November, purchasing 3.13 trillion yen. U.S., German and French sovereign bonds drew notable interest.

Upbeat remarks from major central banks including the Fed, the European Central Bank and the Bank of England in June have boosted global bond yields including those in Japan. But the BOJ have shown little tolerance for this, acting twice in a week to bring yields down by offering to buy an unlimited amount of 10-year bonds, boosting its regular purchases of five-to-10 year debt and increasing buying of three-to-five year notes.

Tricky Timing

Still, getting the timing right for overseas purchases could be tricky. The May purchases by Japanese funds preceded the global bond rout a month later. ECB President Mario Draghi said on Thursday the central bank will put off discussions on winding back stimulus until after the summer.

Japanese investors may sell long-dated bonds if European yields surge as the schedule of the ECB tapering becomes clearer, said Masayuki Kichikawa, chief macro economist at Sumitomo Mitsui Asset Management Ltd. in Tokyo.

"It’s likely that Japanese investors have slowed their purchases of European bonds after Draghi initially made hawkish comments in late June, but the underlying trend for investors to acquire European bonds won’t change given the existing interest gap between Japan and Europe," Kichikawa said. "Investors could shift into short-dated notes when the market is volatile but they could invest back into the longer end of the market when bond yields stabilize."

The BOJ pledged Thursday to maintain the yield-curve control program and asset purchases, and pushed back the projected timing to reach its 2 percent inflation target to fiscal 2019. Although the central bank raised its assessment of the economy, it said inflation expectations remained in a weakening phase.

The yen is expected to stay weak as long as Japan keeps its yield curve control policy, said Akio Kato, general manager of trading at Mitsubishi UFJ Kokusai Asset Management Co. in Tokyo. "Investors holding Treasuries unhedged are likely to continue directing to U.S. bonds as the yen is likely to stay weak," he said.

Market Views:

SMBC Nikko Securities Inc. (Hidenori Suezawa, chief fixed-income strategist)

  • "The U.S. and global economies are clearly recovering, but as there are many uncertainties such as U.S. political risks, rates aren’t expected to rise sharply" 
  • "One thing clear is Japan won’t be tightening for a while, so funds from Japan is likely to go abroad for returns"

Dai-ichi Life Insurance Co. (Eiichi Ohira, deputy general manager)

  • Plans to raise exposure in European peripheral and semi-core sovereign debt when yield spreads have widened sufficiently
  • This could happen after summer if the ECB meetings pass without disruption
  • Dai-ichi Life has around $315 billion in assets under management Mitsubishi UFJ Kokusai Asset Management (Akio Kato):
  • "There is a possibility institutional investors, such as life insurers, may shift back home if the 40-year yield climbs above 1 percent and the 30-year approaches 1 percent" 
  • “Investors have invested abroad in May on the view that yields in the super-long sector were too low. But as the yields rise, investors could have one less incentive to buy foreign bonds."

— With assistance by Chikako Mogi

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