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Japanese investors are selling eurozone government debt at the fastest pace in more than a decade, with analysts warning that a move by one of the bloc's cornerstone holders could lead to a sharp market selloff.
Net sales by Japanese investors rose to 41 billion euros in the six months to November – the latest figures to be published – according to data from Japan's finance ministry and Japan, compiled by Goldman Sachs.
The prospect of higher bond yields at home and political upheaval in Europe — including the collapse of the ruling coalition in Germany leading to elections next month and unrest in France, which is operating under an emergency budget law — accelerated the sell-off, analysts say. French bonds were the most sold during the period for €26 billion.
The sales add to further pressure on indebted European governments already facing a jump in borrowing costs and highlight how rising Japanese interest rates After years in negative territory, financial markets around the world are changing.
Japanese investors coming home is “a game changer for Japan and global markets,” said Alain Bokobza, head of global asset allocation at Société Générale.
Although Japanese investors have been net sellers of Eurozone bonds for most of the past few years, the pace has picked up in recent months.
Japanese investment flows were a “stable source [European] Demand for government bonds for a long time,” said Tomasz Wieladek, economist at asset manager T Rowe Price. However, markets are now “entering an era of Bond vigilance” where “rapid and violent sell-offs” could happen more frequently.
Gareth Hill, bond fund manager at Royal London Asset Management, said the scenario had “long been a concern for European government bondholders, given the historically high views [among] Japanese investors” and could put pressure on the market.
In addition, the rising cost of hedging against swings in the value of the yen has made overseas debt increasingly attractive. Although they are down from the 2022 peak when hedging costs are factored in, the 10-year yield on Italian government bonds for Japanese investors is just over 1 percent, roughly the same as Japan's 10-year yield, according to Noriatsu Tanji, chief slope strategist at Mizuho Securities in Tokyo . He pointed to regional banks in Japan as among the main sellers of European debt.
“Japanese investors have to ask very hard how much they should be holding foreign bonds,” said Andres Sanchez Balcazar, head of global bonds at Pictet, Europe's largest asset manager.
Norinchukin – one of Japan's biggest institutional investors – said last year it planned to offload more than 10 TN of foreign bonds this financial year. In November, it posted a second-quarter loss of around $3 billion after realizing losses from its large holdings of foreign government bonds.
The pullout by Japanese investors is putting upward pressure on bond yields, which have been on the rise since the European Central Bank began a massive bond-buying program during the coronavirus pandemic, analysts said.
France – which has one of the deepest bond markets in Europe and has historically been a favorite among Japanese investors because of the additional yield it offers above benchmark German debt – has seen large Japanese outflows in recent months.
From June to November, as the political crisis deepened, resulting in the fall of Michel Barnier's government, total outflows of Japanese funds reached €26 billion, compared with inflows of just €4 billion in the same period the previous year.
“There is no doubt that the buyer base has changed for France,” said Seamus Mac Gorain, head of global rates at JPMorgan Asset Management.
Over the past 20 years, Japanese investors have become a core investor in several bond markets as very low yields at home have made foreign investment more attractive, even to large investors such as pension funds that need to buy safe sovereign debt.
Japanese institutional investors' total foreign bond holdings peaked at $3 trillion at the end of 2020, according to the IMF.
But as Japanese investors have sought yield at home, their net purchases of global debt securities have shrunk to a total of just $15 billion over the past five years — a far cry from the roughly $500 billion in such purchases they made in the previous five years, according to calculations by Alex Etra , macro strategist at EXANTE.
“While Japanese bonds were quite unattractive for domestic investors in the past, they are now more attractive,” Gorain told JPMorgan. “That's a structural change.”
