Get 40% Off
💰 Buffett reveals a $6.7B stake in Chubb. Copy the full portfolio for FREE with InvestingPro’s Stock Ideas toolCopy Portfolio

Analysis-BOJ pivot no fright for euro zone bonds

Published 03/22/2024, 07:44 AM
Updated 03/22/2024, 07:45 AM
© Reuters. 20 Euro banknotes are seen in a picture illustration, August 1, 2016. REUTERS/Regis Duvignau/Illustration/File Photo

By Yoruk Bahceli

AMSTERDAM (Reuters) - Japanese investors are finally being paid to park their cash back home, a move that might be expected to spook euro zone markets where they're a big force but could ironically prop up demand instead as ECB rate cuts loom.

Stuck with negative rates for two decades, Japanese investors have ploughed into bond markets globally. They are the biggest foreign holders of U.S. Treasuries.

They also have a sizeable presence in the euro zone, where they hold around 1% of the overall bond markets in countries like France, Belgium and the Netherlands, BofA estimated last year.

With French governments bonds a top pick, their share of that market is likely higher.

So, a Bank of Japan decision to hike rates for the first time in 17 years is, on the surface, bearish for European bonds given the bloc's funding needs are high and the European Central Bank is cutting its bond holdings.

But hold on.

The good news, analysts say, is the worst was likely over before the BOJ even considered raising rates.

Since April 2022, Japanese investors have shed half the French, German, Italian and Dutch bonds they accumulated since 2005, BofA estimates.

"People are concerned about what damage there might be to global bonds from Japanese investors. A lot of that's already occurred," said Andre Severino, head of global fixed income at Japan's Nikko Asset Management, which manages $228 billion.

COSTLY

In 2022, hedging costs for Japanese investors buying foreign bonds surged as the BOJ held rates below 0% while others hiked, meaning it became much more expensive to buy overseas bonds on a hedged basis.

3rd party Ad. Not an offer or recommendation by Investing.com. See disclosure here or remove ads .

Investors, such as Japanese life insurers, make derivatives agreements to protect a substantial share of their investments from currency swings when they buy foreign bonds.

The cost of such hedging is driven by the gap between the BOJ and other central bank policy rates. This should become slightly more palatable as the BOJ hikes, while the ECB is seen cutting rates from June and possibly more than the U.S. Federal Reserve given a weaker economy, analysts said.

The ECB's key rate is 4%, versus 0-0.1% in Japan. Markets see the ECB cutting rates to around 3% by year-end, and the BOJ hiking to 0.25%.

To make French bonds competitive relative to Japanese government bonds at current yields, the hedging cost -- around 4% -- would need to decline by 220 basis points, Citi estimates.

It expects that could happen over the next two years, though a fall in French yields relative to Japanese bond yields would dampen the impact.

Overall, Nikko's Severino said he expects stable to positive Japanese flows into foreign bonds, including the euro zone, going forward.

UNHEDGED?

Following 2022's exodus, flows in and out of euro zone government bonds last year were marginal, Nordea data shows, while Japanese investors bought 122 billion euros worth of U.S. Treasuries even as rates differentials widened -- suggesting many purchases were unhedged.

Treasuries should remain the top-pick for unhedged investors given higher yields and a deeper market, Citi reckons, yet French bond appeal should grow relative to Treasuries as euro zone and U.S. economies diverge.

3rd party Ad. Not an offer or recommendation by Investing.com. See disclosure here or remove ads .

Mizuho multi-asset strategist Evelyne Gomez-Liechti said the bank's Japanese clients were not confident last year that the ECB could contain inflation, but now markets expect the ECB to be one of the first banks to ease.

"So, that's probably going to be another green flag for Japanese investors to consider (European government bonds)," she said.

Some inflows could come from pension funds -- often unhedged investors -- who might rebalance their investments as U.S. equities hit record highs, Gomez-Liechti added. She also expects further demand from banks, who shift their investments opportunistically with market moves.

The question is how much longer-dated Japanese government bond (JGB) yields rise.

Nomura chief rates strategist Naka Matsuzawa said once the 30-year JGB yield rises towards 2%, a level he expects to be hit later this year, more selling would follow. It is currently at 1.8%.

"Once the 30-year JGB yield gets back to that level, the lifers no longer really have to keep money in the other markets," he said, referring to life insurers' asset-liability calculations.

Matsuzawa thinks only half the repatriation has taken place so far, but expects further outflows to be gradual. Still, he senses concern in some European quarters.

"The French treasury department keeps asking us what the Japanese flows are, so they must be concerned," said Matsuzawa, adding that the bank receives questions particularly around French debt auctions.

France's debt management office declined to comment.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.