The largest buyer of Treasury outside the United States is quietly selling billions

(Bloomberg) — In times of Treasury turmoil, historically the largest investor outside the United States has lent a helping hand. Not this time.

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Japanese corporate managers – known for their legendary selling of US debt in recent decades – are fueling big bond sell-offs as the Federal Reserve splits its $9 trillion balance sheet.

The latest data from BMO Capital Markets shows that the largest offshore holder of Treasuries has offloaded nearly $60 billion over the past three months. While this may be a small change for Japan’s $1.3 trillion stockpile, divestment threatens growth.

That’s because the monetary path between the US and the Asian nation is diverging ever further, the yen is dropping to a 20-year low, and market volatility is exploding. All of this is to reduce currency hedging costs and offset the allure of high nominal US returns, especially among large life insurance companies.

The bottom line: Japanese accounts contribute to the historical Treasury trajectory and may not return collectively until the benchmark 10-year yield is trading above 3%. Indeed, bonds close to zero at home look more attractive than ever even as US debt offers some of the highest rates in years.

“It’s a lot of selling and on par with what we saw in early 2017 from Japan,” said Ben Jeffrey, pricing analyst at BMO.

While the Fed’s aggressive anti-inflation tightening cycle could lead to several 50 basis point hikes in the coming months, the Bank of Japan remains locked in endless stimulus. This is weakening the yen and driving up the economics of buying Treasury bonds even as the 10-year JGB stays within 0.25%.

While the US 10-year yield was trading at 2.91% as of 6:55 am in New York, buyers paying for protection against fluctuations in the yen-dollar exchange rate are seeing their actual returns dwindle to just 1.3%. That’s because hedging costs have ballooned to 1.55 percentage points, a level not seen since early 2020 when global demand for dollars surged on the path of the pandemic.

A year ago, the Treasury standard was offering a similar return, when factoring in the cost of protecting against moves in the exchange rate thanks to a modest 32 basis points hedging cost.

Ichiro Miura, general manager of the fixed income division at Nissay Asset Management Corp. Hedging costs are the case for investing in US Treasuries.

The Fed’s tightening cycles and accompanying market volatility have moderated Japanese purchases of Treasuries in the past. But in this cycle, the high level of uncertainty surrounding US inflation and interest rate policy could lead to a long-term absence. Meanwhile, Japanese traders returning from the Golden Week holiday have other options abroad as the euro’s hedging costs remain near the one-year average.

Tatsuya Higuchi, CEO of Funds at Mitsubishi UFJ Kokusai Asset Management Co., said: “Among the Eurobonds, Spain, Italy or France look attractive given the spreads.”

Typically Japanese buyers favored intermediate sectors of the Treasury curve from five- to 10-year bonds, while life insurance companies and pension funds focused on 30-year bonds. But hopes that the Treasury market will see long-term buying in the new fiscal year that began in April have been dashed as some life insurers reconsidered their exposure to foreign debt, given the currency volatility spurred largely by a tight monetary shift at the US central bank.

John Madzier, Portfolio Manager at Vanguard Group Inc. “Are you really going to buy when Treasuries are likely to reach more attractive levels?”

One broad Treasury index is already experiencing a loss of more than 8% so far this year. Much now depends on whether the 10-year can consolidate in the range of 2.80% to 3.10% this month once the market absorbs the next meeting of the Federal Reserve along with the quarterly debt sales from the US Treasury.

“Japanese investors will wait for some stability in long-term returns before they feel a buying opportunity,” said George Goncalves, head of macro strategy at MUFG. “If the 10 years stabilize through May, that will help attract buyers and at those yield levels you are getting compensated now.”

(Updates yield to the level in the eighth paragraph.)

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