The world's second-largest pool of sovereign debt is now vulnerable to spikes in volatility caused by traders thousands of miles away as foreign investors pour into Japan's once-calm government bond market.
According to data from the Japan Securities Dealers Association, foreign investors now make up over 65% of monthly cash JGB transactions, up from 12% in 2009. According to Ministry of Finance figures, they are on track to purchase more Japanese government bonds this year than at any other time since records started in 2005, but not everyone is a buyer, and more foreign involvement also increases the potential of a swift or chaotic withdrawal.
The change occurs during a delicate period for Japanese decision-makers. As the Bank of Japan reduces its own bond purchases, Prime Minister Sanae Takaichi unleashed the nation's largest spending spree since epidemic restrictions relaxed.
Yields have already reached multi-decade highs. The entrants, which range from hedge funds to international asset managers, are a source of demand as well as a layer of volatility that could affect Treasuries, gilts, and bunds due to Tokyo's $7.4 trillion bond market.
Foreign traders can quickly sell down their holdings and have more investing options than their Japanese counterparts, according to Stephen Miller, a consultant at the funds management company GSFM.
Miller, who is headquartered in Sydney and has more than 40 years of market expertise, stated, "It's very, very important that Takaichi does everything to retain the confidence of foreign investors."
He stated that she "doesn't have to have a misstep as egregious as the one that Liz Truss had to potentially frighten foreign investors," alluding to the kind of whiplash that embarrassed the UK during Truss' tenure as prime minister when a sudden lack of confidence sent gilt yields down.
Even though a Truss-style crash may not be near, the threat of a confidence shock is becoming more real as public debt is expected to exceed ¥1.45 quadrillion ($9.3 trillion) this year, or around 230% of GDP.
The highest yields in years, which can be boosted by currency hedges, are part of the purchase case for overseas investors. In a webinar, Marc Seidner, chief investment officer of non-traditional strategies at Pacific Investment Management Co., stated that when JGBs are hedged back into nearly every other currency, they "look like a clear high yielder."
Even still, it's difficult to ignore the reality that Japan's bonds have already underperformed globally this year. The 20- and 40-year yields have each increased by roughly a percentage point throughout that time, while the 30-year yield reached a record high this month.
Japan is currently referred to by Goldman Sachs Group Inc. as "a net exporter of bearish shocks," a description that many traders believe sums up the situation.
Sydney-based Kellie Wood is one of the offshore investors capitalizing on the volatility. She seldom looked at JGBs five years ago.
The equities are currently being aggressively traded by Schroders Plc's money manager, who is in charge of more than $1 trillion. She stated that she has bearish JGB positions and added, "We believe the BOJ policy path is under-priced in markets."
The idea that offshore funds have decisive power is not universally accepted. Global capital can only go so far, according to experts like Hirofumi Suzuki, chief currency strategist at Sumitomo Mitsui Banking Corp. in Tokyo.
According to central bank data published by Bloomberg, the BOJ owns more over 50% of outstanding debt, domestic life insurance control 12.8%, banks own 11%, and pension funds keep 9.1%.
These investors continue to provide stability that fast-moving hedge funds are unable to match. According to the figures, foreigners only make up 6.5%.
For her part, Takaichi has indicated that she is prepared to reassure investors. She recently stated that this fiscal year's overall bond issuance will be less than the ¥42.1 trillion from the previous year.
Howe Chung Wan, head of Asian fixed income at Principal Asset Management, which manages more than $600 billion, stated, "Policymakers are aware of the under-performance in JGBs relative to other government bond markets."
"Given her more aggressive fiscal policy, the Takaichi government should be in a better position to address this issue than her predecessors."
Even so, it's difficult to ignore the fissures. According to estimations by Bloomberg News, the volatility of Japan's government bonds has more than tripled since 2021.
Overseas funds are filling the void left by the BOJ's pullback from its enormous influence. Additionally, foreign traders are eager to take advantage of new opportunities to sell JGBs because another rate hike is likely given that inflation is still far higher than the central bank's 2% target.
Additionally, despite having comparatively tiny JGB holdings, foreign owners have a greater influence on the market since they are more opportunistic than domestic owners.
In contrast to local life insurance, pension funds, and even local banks that maintain JGBs as a requirement on their balance sheets, foreign investors typically have higher turnover, trade for profit, and are "less sticky."
According to Matthew Ryan, head of market strategy at financial services company Ebury, "Japan is increasingly becoming the world's new volatility exporter."
"The days of "free money" are over." According to Luigi Buttiglione, the CEO of LB Macro SA and a former partner at Brevan Howard, Japan's turning point is no longer speculative. He claimed that rising yields and volatility could cause the world's financial markets to collapse.
Buttiglione stated, "The impact on global market volatility will be greater the later the BOJ decides to align and possibly surpass neutral levels, the higher they will have to go."
