Investors worried about the Bank of Japan’s threat to global markets have a chance to hear from those on the front lines in coming weeks.
(Bloomberg) — Investors worried about the Bank of Japan’s threat to global markets have a chance to hear from those on the front lines in coming weeks.
Japan’s life insurers, with combined assets of $2.9 trillion, will lay out their investment strategies for the fiscal year which began this month. A key constituent of the country’s investor base, their plans for foreign and domestic markets this year will help shine a light on how Japanese funds are positioning for a potential BOJ policy tweak.
For months now, investors have bet that the central bank will start to normalize its ultra-easy monetary policy and change its yield-curve control program as inflation accelerates. That’s led to higher Japanese bond yields, making them more attractive to insurers who face expensive hedging costs and losses on foreign securities.
Insurers sold a record ¥14.2 trillion ($107 billion) of foreign bonds in the previous fiscal year while buying ¥4.99 trillion of local equivalents in the first 11 months, according to the latest data. That made up a big part of Japan’s record foreign bond outflows in 2022, which sent a chill through holders of everything from US government bonds to Brazilian debt, where the country’s funds are big investors.
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Market watchers are bracing for volatility, should Japanese investors increase their sales of foreign securities and bring some of that cash home. Dai-ichi Life Holdings Inc., a life insurer with one of Japan’s largest institutional portfolios, said last month that it’s shifting more money to domestic bonds from US Treasuries and other foreign securities.
Some strategists expect the insurers to stay focused on domestic bonds, particularly longer-dated ones, with hedging costs for foreign investment still at elevated levels. Others see the potential for the overseas outflows to reverse, with the Federal Reserve expected to moderate the pace of its rate hikes and new BOJ governor Kazuo Ueda seen eventually tweaking policy.
Mizuho Securities Co. Chief Desk Strategist Shoki Omori expects life insurers to stay focused on domestic debt partly because they need to hold an additional ¥35 trillion of long-maturity Japanese government bonds to meet asset-liability management requirements by April 2025, when a new solvency regime will be implemented. In addition, controlling currency risk is too expensive now.
“They will continue to be cautious on overseas bonds as they see high grade bonds including sovereigns such as Treasuries being too rich on both a hedged and unhedged basis,” Tokyo-based Omori said. “Hedging costs are too high at around 5% and the dollar-yen is too high to go outright at current levels.”
While Ueda has said he doesn’t plan any immediate changes to policy, global credit investors should be particularly nervous, according to Citigroup Inc. Strategists Daniel Sorid and James Keefe see Japanese outflows spreading from Treasuries and agency bond markets, if the BOJ adjusts its curve control policy and local yields rise.
“The next wave of foreign bond reductions by Japanese life insurers could more squarely hit corporate bond demand,” they said.
Higher yields in Japan would favor the local corporate bond market, according to Tomoaki Shintani, chief fund manager of the credit research department at Fukoku Capital Management Inc.
“If domestic yields start rising, it makes sense to allocate money to domestic credit to some extent while reducing risks in foreign bonds,” he said.
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Still, others see it differently. Investor focus has shifted to when the Fed will pause or even roll back its rate hikes if the US economy slows, adding to the allure of havens like Treasuries, especially with Japan’s yields so low on an absolute basis. The US 10-year note yields around 3 percentage points more than its Japanese counterpart.
“Should I be a fund manager at a life insurance company, there probably is no choice but to pour funds into foreign debt,” said Jun Kato, chief market analyst at Shinkin Asset Management Co. in Tokyo. “Japanese yields will eventually rise, making it hard to buy them now.”
For Ayako Sera, market strategist at Sumitomo Mitsui Trust Bank Ltd., the shift in investor sentiment also suggests equities won’t find favor with the insurers.
“As the global economy is showing signs of a slowdown, they are unlikely to aggressively add to stock holdings,” she said.
Sera suggests the level of the yen, which has slipped about 1% this year to around 132.50 per dollar, and yields on Japan’s longer-dated bonds will be key determinants of where the lifers invest their cash. The Japanese 30-year yield was around 1.3% on Friday, up from about 0.9% a year ago.
“It’s hard to aggressively construct hedged foreign-bond positions and so, they may buy foreign bonds when the yen strengthens to 120s,” she said. “Super-long JGBs where yields have gone up compared with last year seem to be attractive for them as well.”
–With assistance from Ayai Tomisawa, Masahiro Hidaka and Hideyuki Sano.
(Updates price levels)
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