Japan Adds to Bond Route Selling Treasuries as Currency Hedging Costs Soar

Bonds have collapsed at a rapid pace with soaring inflation and a one-way market. The US dollar has soared at the same time with the BOJ and the Fed Reserve at difference policy ends. The Japanese Central Bank still is an aggressive buyer of JGB’s while the Fed pares its $9 trillion balance sheet. Japanese institutional managers are now selling US bonds, BMO Capital Markets shows they have offloaded almost $60 billion over the past three months.

Via BMO/Bloomberg

One could argue this is small potatoes relative to Japan’s $1.3 trillion stockpile, it is the potential flow on if this becomes an escalating pattern of selling.

“It’s a significant amount of selling and on par with what we saw in early 2017 from Japan,” said Ben Jeffery, BMO’s rates strategist. 

With the yen falling to 20-year lows and market volatility at extreme levels, the different volatility measures are printing extremes which means hedging tools are expensive.

Given the currency risk and hedging costs the appeal of higher nominal U.S. yields loses its luster, especially among large life insurers and pension funds as they focus on the longer tenors such as 30-year bonds. An aggressive Fed means rates likely go higher leading investors to hold off on longer duration assets.

With the expectation of an aggressive Fed tightening cycle to combat inflation and the market pricing in multiple 50 basis-point hikes at the same time the Bank of Japan remains locked in endless stimulus. That’s weakening the yen and upending the economics of buying Treasuries even as the 10-year Japanese government bond remains capped around 0.25%.

10-year U.S. yields traded at 3% in New York trading Monday, when you add in the hedging cost for dollar yen the effective yields are just 1.3%. Hedging costs have ballooned to 1.66 percentage points, early 2020 levels when the global demand for dollars spiked in the pandemic rout. a year ago, USDJPY was at a 32 basis-point hedging expense.

“Hedge costs are the issue for investing in U.S. Treasuries,” said Eiichiro Miura, general manager of the fixed-income department at Nissay Asset Management Corp.

Euro is now a more attractive option as euro-hedging costs remain near the one-year average. 

“In the span of next six months or so, investing in Europe is better than the U.S. as hedge costs are likely to be low,” said Tatsuya Higuchi, executive chief fund manager at Mitsubishi UFJ Kokusai Asset Management Co. “Among the euro bonds, Spain, Italy or France look appealing given the spreads.”

Eyes are on whether the 10-year can consolidate in a range of 2.80% to 3.10% this month once the upcoming Fed meeting is absorbed by the market along with quarterly debt sales from the U.S. Treasury.

“Japanese investors will wait for some stabilization in long-dated yields before they sense a buying opportunity,” said George Goncalves, head of macro strategy at MUFG. “If the 10-year settles during May, that will help attract buyers and at those yield levels you are getting compensated now.”

The Fed meeting have profound affects among multiple markets, a fact missed by many. From here we watch the forward margins for hedging and investment indications and the EURJPY exchange rate.

Source: Bloomberg, BMO

From The TradersCommunity Research Desk