(Bloomberg) — In times of Treasury crisis, the biggest investor outside of U.S. soil has historically lent a helping hand. Not this time.
Bloomberg’s Most Read
Japanese institutional managers – known for their legendary purchases of US debt over the past decades – are now fueling the big bond sell-off just as the Federal Reserve is shrinking its balance sheet by $9 trillion.
The latest data from BMO Capital Markets shows that the largest foreign holder of Treasuries has unloaded nearly $60 billion in the past three months. While that may be a small change from Japan’s $1.3 trillion stock, divestment threatens to grow.
Indeed, the monetary trajectory between the United States and the Asian nation is increasingly diverging, the yen is hitting its lowest level in 20 years, and market volatility in the United States is erupting. All of this raises the costs of currency hedging and completely negates the appeal of higher nominal US yields, especially among large life insurers.
The result: Japanese accounts are contributing to the historic treasury rout and may not come back in droves until the benchmark 10-year yield trades firmly above 3%. In fact, near-zero yield bonds are looking increasingly attractive even as US debt offers some of the highest rates in years.
“This is a significant amount of sales and comparable to what we saw in early 2017 from Japan,” said BMO rate strategist Ben Jeffery.
While an aggressive Fed tightening cycle to fight inflation could lead to multiple 50 basis point hikes in the coming months, the Bank of Japan remains locked in endless stimulus. This weakens the yen and upends the economics of buying Treasuries even as the Japanese 10-year government bond remains capped at around 0.25%.
While the sell-off pushed the US 10-year yield to around 2.9%, buyers paying to hedge against swings in the yen-dollar exchange rate are seeing their effective yields drop to just 1.3%. Indeed, hedging costs soared to 1.55 percentage points, a level not seen since the start of 2020, when global demand for dollars soared in the pandemic rout.
A year ago, the Treasury stock offered a similar yield, taking into account the cost of protecting against exchange rate fluctuations thanks to a modest hedging cost of 32 basis points.
“Hedging costs are the problem with investing in US Treasuries,” said Eiichiro Miura, managing director of the fixed income department at Nissay Asset Management Corp.
Fed tightening cycles and associated market volatility have tempered Japan’s purchases of Treasuries in the past. But in this cycle, the high level of uncertainty surrounding inflation and interest rate policy in the United States could trigger an extended absence. At the same time, Japanese traders returning from the Golden Week holiday have other options overseas as euro hedging costs remain close to the one-year average.
“Over the next six months or so, it’s better to invest in Europe than in the US, as hedging costs are likely to be low,” said Tatsuya Higuchi, executive director of fund manager at Mitsubishi UFJ Kokusai Asset. Management Co. “Among euro bonds, Spain, Italy or France look attractive given the spreads.
Generally, Japanese buying favored the middle sectors of the Treasury curve, ranging from 5- to 10-year bonds, while life insurers and pension funds focused on 30-year bonds. But hopes that the Treasury market would see long-term buying in the new fiscal year that began in April have been dashed as some large life insurers rethink their exposure to foreign debt, given currency volatility spurred in largely by hawkish monetary change at the US central bank.
“The Fed is super aggressive,” said John Madziyire, portfolio manager at Vanguard Group Inc. “Are you really going to buy when Treasuries likely hit more attractive levels?”
A general Treasury index is already sitting on a loss of more than 8% so far this year. Much now hinges on the 10-year’s ability to consolidate in a 2.80% to 3.10% range this month once the next Fed meeting is absorbed by the market with quarterly debt sales. of the US Treasury.
“Japanese investors will wait for some stabilization in long-term yields before they sense a buying opportunity,” said George Goncalves, head of macro strategy at MUFG. “If the 10yr moves into May, that will help attract buyers and at those yield levels you are now compensated.”
Bloomberg Businessweek’s Most Read
©2022 Bloomberg LP