Treasury Traders Seek Moment of Truth From Japan

(Bloomberg) -- As Japan’s life insurers lay out their annual strategies this month, traders will be looking for the answer to one question -- what do some of the world’s biggest investors plan to do about Treasuries?

With the path of Treasury yields set to determine investments across the financial world, the intentions of a large cohort of the biggest foreign holders of U.S. government debt will be a crucial input. Japanese investors were on track to be net sellers of Treasuries for the sixth year in seven in their fiscal year to March, according to U.S. Treasury data through January. Some predict a return to purchases in 2021.

With combined assets equivalent to $3.6 trillion, and one-quarter of this in foreign securities, even minor shifts in Japanese insurer allocations can impact markets. Furious selling by Japanese funds in February helped fuel the biggest monthly decline in Treasuries since 2016, and with benchmark yields close to their highest in a year, bond investors are keen to know at what levels lifers will become more inclined to buy.

“Life insurers are expected to be aggressive about investing in foreign bonds, and are probably looking for the right timing to buy when markets settle down,” said Hiroshi Yokotani, managing director and portfolio strategist for fixed income and currencies at State Street Global Advisors. “The U.S is seen to be the most attractive destination taking account of hedge costs.”

Life insurers will start announcing their allocation plans for the new fiscal year later this month. Among them are the nation’s leading Nippon Life Insurance Co. and Japan Post, which is also known as Kampo Life.

Treasuries Attraction

After reaching a record closing low of around 0.5% last August, the 10-year Treasury yield has rebounded and traded at just over 1.60% on Wednesday. That increase makes Treasuries relatively more attractive to some of the credit products which have been preferred by Japan’s life insurers in recent years, where spreads have tumbled close to historic lows.

“Credit investment has depressed spreads to historically expensive levels, so investing in Treasuries looks safer in the longer run,” said Akio Kato, general manager of strategic research and investment at Mitsubishi UFJ Kokusai Asset Management. “Abundant cash held by investors will keep money flowing into credit but it’s doubtful if the size will be big.”

Given the recent flattening of the U.S. 10-year/30-year yield curve -- where the spread was about 68 basis points on Wednesday -- lifers may wait until it steepens back toward 100 basis points before buying Treasuries, Kato added.

For State Street’s Yokotani, Treasuries are also more attractive than agency bonds -- such as those of Freddie Mac or Fannie Mae -- which tend to be more volatile when yields are rising.

Hedge Call

Aside from choosing where to invest, Japanese investors also have to decide whether to hedge out their currency risk or not. The yen was the worst-performing Group-of-10 currency in the first quarter of 2021 and is down over 5% against the dollar year-to-date.

Short-term rates pinned at low levels have kept hedging costs near historic lows, providing a favorable environment. Japanese investors currently get a yield of almost 1.3% from a 10-year Treasury note after taking account of hedging costs, compared to just 0.65% for local 30-year government bonds.

“Returns generated from currency-hedged U.S. Treasuries investment could be too attractive to resist,” said Satoshi Nagami, head of the global strategies investment group at Sumitomo Mitsui DS Asset Management Co. Japanese investors “wouldn’t be too aggressive early in the new fiscal year, but I don’t think they feel negative about allocating funds into overseas debt this year.”

Life insurers extended a net sale of foreign bonds for a ninth consecutive month in March, the longest ever streak in Ministry of Finance data going back to 2001. That made them a net foreign bond seller for a fiscal year for the first time in seven years.

Still, not everyone is convinced Japan’s investors will rush back into Treasuries given the risk yields could continue to rise -- Masahiko Loo, fixed-income portfolio manager at AllianceBernstein Japan in Tokyo sees credit continuing to attract more interest. But a consensus does seem to have formed on where they will invest.

“This year, Japanese investor strategy will be simple, to focus on the U.S.,” Loo said.

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