It’s easy to see why Japan has soured on Uncle Sam.
After all, returns on Treasuries have been lousy for years. And the sky-high costs to hedge the dollar’s ups and downs mean Japanese investors can often do better at home — despite the minuscule yields there.
But it doesn’t mean they’ve given up on America altogether. In fact, investors from Japan have plowed record amounts into U.S. stocks, corporate bonds and agency-backed securities, pushing investments in those assets past $1 trillion for the first time ever this year. That’s a stark contrast to the big pullback from Treasuries, which has cut Japan’s holdings to a seven-year low.
The shift reflects a sea change in Japanese investing. For decades, the U.S. Treasury market has been the go-to destination for the nation’s historically risk-averse investor base. Faced with ultra-low returns in Japan, the yield pickup from owning the world’s pre-eminent haven asset was a no-brainer, and more than covered any currency-hedging costs. But now, as those expenses soar, traditional Japanese buyers of Treasuries such as pension funds and insurers have been forced to look elsewhere.
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“The rising hedge cost has pushed Japanese investors out of their favorite foreign product: U.S. Treasuries,” said Tetsuo Ishihara, a U.S. macro strategist at Mizuho Securities USA’s fixed-income unit. “In general, they have had to take more risk to offset that rise.”
The consequences could be significant. With the U.S. budget deficit forecast to balloon in coming years, any drop-off in demand for Treasuries could increase America’s financing costs. As the second-largest foreign creditor to the U.S., Japan’s standing is too important to simply ignore.
At the same time, Japanese investors are building up risk — echoing the demand for higher-yielding assets globally in response to ultra-low rates of the post-crisis era — just as worries about both stocks and corporate bonds in the U.S. have started to emerge.
Since 2015, Japan’s investments in U.S. stocks, corporate bonds and agency-backed bonds have grown by over $270 billion, or roughly 40%, figures from the Treasury Department show. Investors from Japan have been particularly aggressive in amassing stocks and agencies, relative to buyers from other countries, the data show. Over the same span, their holdings of Treasuries have fallen nearly 20% to $1.03 trillion.
To understand why, consider what Treasuries actually yield for a typical Japanese investor. After taking into account the cost of currency forwards used to insulate buyers against dollar swings, 10-year yields — currently at 2.83% — effectively shrink to about 0.3% for yen-based investors.
Of course, that’s still higher than the yield on 10-year JGBs, which is barely above zero. But looking solely at yield levels arguably misses the point that matters most: what the trade returns after factoring in currency swings.
And this year, it hasn’t been pretty.