Japanese banks are likely to double down on US Treasurys investments as local interest rates are expected to rise further, making it riskier for them to allocate more cash to Japanese government bonds.
Data from the Japanese megabanks — Mitsubishi UFJ Financial Group Inc. (MUFG), Sumitomo Mitsui Financial Group Inc. (SMFG) and Mizuho Financial Group Inc. — show they have already been accumulating foreign bonds, including US Treasurys, while shedding JGBs in the past year. Their aggregate holdings of foreign bonds rose to ￥47.61 trillion as of December 2023 from ￥40.64 trillion a year ago. On the other hand, their holdings of Japanese government bonds (JGBs) fell to ￥43.95 trillion from ￥48.11 trillion.
"How can [Japanese banks] bet on government bonds [in Japan] amid growing expectations of higher interest rates?" said Tsuyoshi Ueno, a senior economist at NLI Research Institute. "Their attention is turning to overseas bonds because US rates are expected to move lower, although the timing [of the US Federal Reserve rate cuts] could be pushed back."
Japan and the US are set to pursue divergent monetary policies, with the Fed likely to cut the benchmark rate once or twice by year-end. Such a move would turn around bond prices weighed down by a series of rate hikes, economists predict, although they are marking down the timing of the policy shift. On the other hand, the Bank of Japan (BOJ) is expected to hike rates further amid the yen's depreciation against the US dollar, increasing unrealized losses in sovereign debt assets for investors.
In March, the BOJ decided to guide its short-term policy rate in the range of 0% to 0.1%, from the prior negative 0.1% introduced in 2016. The move is seen by economists as an initial step to set the terminal rate at 1.0% to 1.5% in a few years.
Divergent monetary policies
The gradual rate hike in Japan would keep US Treasurys attractive enough for Japanese banks to consider, economists said, as the Fed could start quarter-point rate cuts from the current 5.25% to 5.50% range later this year. A narrower gap between US and Japanese policy rates would also reduce the cost of hedging foreign-exchange risk for Japanese investors.
"The situation of the US rates would make it easier [for Japanese banks] to invest there as the long-term yields do not fluctuate," Nana Otsuki, a senior fellow at Pictet Asset Management (Japan). "On the contrary, additional rate hikes [in Japan] would increase mid- and long-term yields and this could create a risk scenario" for their bond investments.
The 10-year Treasury yielded at 4.663% on April 26 after hitting a multiyear high of 4.908% on Oct. 18, 2023. The Fed has held steady since it delivered a 25-basis-point increase in the benchmark rate on July 27, 2023.
The Japanese government bonds with the same maturity traded at 0.882% on the same day of April, their yield increasing from 0.732% on March 19, when the BOJ announced the policy shift. The central bank also removed a cap on the long-term yields, ending its yield-curve control policy.
"For now, they [Japanese banks] are on the sidelines of the bond market [in Japan] and they won't rush to buy more [bonds] before interest rates go up," said Shinichi Tamura, a senior analyst at Okasan Securities Co. "But they are back to a normal mode to sell or buy overseas bonds actively."
More rate hikes likely
Japan's central bank is expected to hike interest rates further to contain inflation and arrest the yen's free fall against the US dollar, according to analysts. In fact, the central bank itself has not ruled out the possibility of raising policy rates further.
"Depending on incoming data and information, we may change the shorter policy rate," BOJ Governor Kazuo Ueda said April 19 at the Peterson Institute for International Economics in Washington, DC. "If underlying inflation continues to go up, we will be very likely raising interest rates."
ING, for instance, expects the BOJ to raise rates by 15 basis points (bps) in July, followed by a 25 bps hike in October, it said in an April 26 note.
In addition, the BOJ's decision in March to end negative interest rates pushed the Japanese yen down to a 34-year low of ￥160 against the US dollar on April 29. A weakened yen leads to higher import prices, an issue that the country's government is grappling with. That could boost the case for the BOJ to further tighten its monetary policy stance to arrest the yen's free fall, economists said.
Vincent Chung, associate portfolio manager for T. Rowe Price's diversified income bond strategy, said the Japanese yen may continue to depreciate towards 160 per US dollar.
"In the context of the interest rate differential with the US, [Japanese yen] longs are likely more reliant on additional Fed rate cuts to be priced into the market rather than the BOJ quickly hiking rates," Chung said in an April 29 note. "Currently, the market is expecting 1.5 rate cuts in 2024 for the US, which means the market has priced out a significant amount of rate cuts."