(Bloomberg) - Treasuries are off to their worst start to a year in over four decades, but a familiar set of supporters may soon ride to their rescue.
Momentum is building for Japanese investors -- the biggest foreign holder of U.S. bonds -- to ramp up purchases, with recent auctions showing strong overseas demand and fund managers signaling there’s no real alternative. They are seen waiting for a volatile March to pass before positioning for the start of the new fiscal year in April -- having been notable bond sellers on accelerating bets of Federal Reserve rate hikes.
“In the new fiscal year, there is no change for U.S. Treasuries to be quite an important investment destination for Japanese investors,” said Satoshi Nagami, head of the asset allocation group at Sumitomo Mitsui DS Asset Management Co. But “until U.S. monetary policy path becomes firm and clear, it would be difficult to immediately jump in on buying.”
Bond market volatility has picked up this month with Treasuries selling off when hawkish expectations for rate hikes are in the ascendancy and rallying when geopolitical sentiment worsens. Benchmark yields fell below 1.9% in Asia trading Tuesday amid the deepening tensions in Ukraine.
But recent U.S. auctions have shown a surge in demand from foreign investors, as 10-year U.S. yields traded close to 2%. For the Japanese, European debt is still seen as less attractive even after German bunds broke above zero earlier this year, while the Bank of Japan caps yields at home.
The currency-hedged yield on benchmark 10-year Treasuries was 1.21% on Friday, compared to 0.61% for an equivalent position in German bunds and 0.94% on 30-year Japanese government bonds, according to data compiled by Bloomberg. U.S. markets were shut on Monday for a public holiday.
Double Whammy
A double whammy of soaring inflation and the Fed laying the groundwork for rate hikes have helped send a Bloomberg gauge of Treasuries down about 3% so far this year -- its worst start since at least 1980. A spike in volatility and the potential for a super-sized rate hike in March are some of the reasons Japan’s fund managers have remained on the sidelines.
While it’s hard to quantify the effect on Treasuries a ramp up in purchases by the Japanese could have, historical periods when they pulled back from the market often coincided with spikes in yields.
“Japanese investors are taking a wait-and-see stance because of the risk of a 50 basis point Fed rate hike in March,” said Naokazu Koshimizu, a senior rates strategist at Nomura Securities Co. in Tokyo. “If the Fed lifts the rate by 50 basis points in March, inflation slows in the April-June period and it becomes more likely that the Fed will hike at a slower pace, then I’d expect Japanese demand for Treasuries to materialize.”
Koshimizu spoke before comments Friday from New York Fed President John Williams leaning against a half-point move, which led traders to pare back their expectations for March. On Monday, Fed Governor Michelle Bowman suggested that a half percentage-point increase could be on the table if incoming inflation data is too high.
The rise in yields has been global, so there are other avenues for Japanese money. Uncertainty over the pace of rate hikes across the Pacific suggests some may consider bonds from Europe.
“Relative carry income is higher for U.S. than Europe now, but the difference with the U.S. is that the pace of rate hikes would be slow in Europe,” said Eiichiro Miura, general manager of the fixed-income department at Nissay Asset Management Corp. “While life insurers will likely keep certain allocations to Treasuries, they may also turn to Europe, keeping in mind the risk of U.S. rate hikes accelerating.”
Local Intervention
And while yields in Japan have also climbed -- the 30-year yield came close to 1% Thursday, its highest since February 2016 -- the BOJ anchors it with its yield-curve control policy. The central bank intervened in 10-year bonds on Feb. 14 and some traders are speculating it could also do something on longer-dated securities.
That suggests the demand for Treasuries will continue -- Japanese investors bought more of them than bonds from any other market last year, even as they cut purchases by almost half to 5.5 trillion yen ($47.7 billion).
“We do expect that the Japanese buying of Treasuries will persist, especially once the financial year end has passed, and for as long as the BOJ holds rates down in Japan,” said Andrew Mulliner, head of global aggregate strategies at Janus Henderson.
(Updates yields in fourth paragraph.)
By Chikako Mogi, Masaki Kondo and Garfield Reynolds
