Skyscrapers in Shinjuku, Tokyo.

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Japanese banks, among the biggest investors in overseas debt, may repatriate funds as the central bank eases its control on yields, making domestic bonds more appealing.

In August, five of Japan's largest banks, including Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc., collectively acquired ¥566.1 billion of mid- and long-term Japanese government bonds (JGBs) on a net basis. This marked a reversal from the combined sell-off of ¥764.1 billion in July, according to data from the Japan Securities Dealers Association.

Regional banks also increased their JGB holdings, purchasing a net total of ¥476.5 billion in August, compared with ¥177.5 billion the previous month. Among these investments by major and domestic lenders, medium-term bonds accounted for ¥748.8 billion, while long-term bonds represented ¥293.8 billion.

The Bank of Japan (BOJ) said July 28 that it would allow benchmark 10-year JGB yields to rise up to 1.0%, following a decision made in December 2022 to permit them to rise up to 0.5%. These adjustments to the regulator's yield curve control policy are viewed as a step toward monetary policy tightening. While Japan maintains its negative interest rate policy, most analysts anticipate an increase in benchmark rates in the coming months.

Shifting away from foreign debt back to domestic bonds is "a major theme for investors for the rest of the year," Haruyasu Kato, a fund manager at Asset Management One, told S&P Global Market Intelligence.

"Such moves should be accelerated when the yields rise toward 1.0% as yen bonds could be more attractive than foreign debt for them given the high hedging cost" they have to pay for buying foreign bonds, Kato said.

Rising yields

The yield on the benchmark 10-year JGBs has remained above 0.70% since Sept. 11, reflecting expectations of tighter monetary policy. On July 27, the 10-year JGB yielded 0.441% just before the central bank adjusted its yield curve control policy. By comparison, the yield on the comparable 10-year US Treasury bond increased to 4.361% on Sept. 19, from 4.002% on July 27.

Analysts anticipate that banks would raise their investments in midterm JGBs as the 10-year yields rise and stabilize around 1%. While analysts hold differing views on the timing, they generally agree the central bank would discontinue negative rates within months. The BOJ's Sept. 21–22 monetary policy review meeting is not expected to result in changes to interest rates that were first introduced in 2016.

"It's a matter of time before Japanese investors turn to yen bonds," said Kazuhiko Sano, a fixed-income strategist at Tokai Tokyo Securities Co.

The BOJ, which has aimed to promote financial market stability through unconventional monetary policies, could potentially introduce volatility that impacts the global debt market.

Policy normalization

Policy normalization in Japan could significantly impact global bond markets, the European Central Bank said in May. "If the BOJ decides to normalize its policy, this might influence the decisions of Japanese investors who have a large footprint in global financial markets," the ECB said.

Japanese holdings of US Treasury securities totaled $1.112 trillion in July, accounting for 14.5% of the total owned by overseas investors. This represented a slight decrease from $1.127 trillion in May, according to US Department of the Treasury data. Chinese investors, on the other hand, held 10.7% of foreign ownership in US Treasurys.

Japanese banks "will definitely return to risk-free JGBs, while they could sell the Treasury to lock in profit when the interest rates hike cycle [in the US] runs its course," Toyoki Sameshima, a senior analyst at SBI Securities Co., told Market Intelligence.

Following the Federal Reserve's rate hike in July, US employment data for August indicated a decrease in the overheating labor market. "A view is now growing that the US interest rate hike is over," said Takahide Kiuchi, executive economist at Nomura Research Institute.

As of Sept. 20, US$1 was equivalent to ¥147.64.