Japanese investors have sold off eurozone government debt at the fastest pace in a decade, suggesting that the move by one of the major holders of European debt could lead to a sharp sell-off in the market. Gross online sales by Japanese buyers rose to 41 billion euros in the six months to November, the latest figures available, according to data from Japan’s Finance Ministry and the Bank of Japan.
Why is the European debt market losing one of its biggest investors?
1. The Bank of Japan’s interest rate hike. The BOJ raised its benchmark interest rate by 0.5%, the highest level since 2008, pushing the yen up 0.7% against the dollar to 155.01. The BOJ still maintains the lowest benchmark interest rate in the world, compared to the Swiss National Bank.
2. The new Trump presidency threatens to shake up Asian economies with a barrage of tariffs, which will certainly hit Japan’s economy – and monetary policy must adapt to the new reality.
3. Αt the same time, rising political risk in Europe — with the collapse of the ruling coalition in Germany leading to elections next month and turmoil in France, which is operating on an emergency budget (it has not been approved by the legislature amid disagreements) — has accelerated gross government bond sales, analysts said. French bonds recorded the largest sales during the period, at 26 billion euros.
The Age of Vigilance – The Japanese Are Coming Home
The debt sales are adding to the uncertainty for heavily indebted European governments already experiencing a spike in borrowing costs and highlight how rising Japanese interest rates, after years in bear territory, are reshaping currency markets around the world.
The Japanese investors returning home are a game changer for Japan and global markets. While the Japanese have been sellers of eurozone bonds for much of the past year, the pace has picked up in recent months.
Japanese funding flows have been “a steady source of demand for [European] government bonds for a long time.” However, debt markets are in fact “entering an age of vigilance,” where “rapid and violent sell-offs” could become the norm.
Rising hedge prices against fluctuations in the value of the yen have made investing in foreign debt less and less attractive. Regardless of the 2022 cap on hedge costs, the yield on 10-year Italian bonds for Japanese buyers is just over 1%, which is about the same as the yield on 10-year Japanese bonds.
Regional banks in Japan are among the most important sellers of European debt.
The fallout
The pullback by Japanese buyers is pushing up bond yields that had already risen as the European Central Bank began reducing its holdings of bonds in its budget following an emergency bond-buying program through the coronavirus pandemic, analysts said.
The French debt market – which has one of Europe’s deepest bond markets and has traditionally been a favorite of Japanese buyers as a result of its higher yield spread over German debt – has seen huge Japanese outflows in recent months.
Between June and November, as the political crisis intensified that led to the fall of Michel Barnier’s government, total Japanese capital outflows reached 26 billion euros, compared with gross sales of just 4 billion euros in the same period last year.
Over the past 20 years, Japanese buyers have emerged as the most important investor in some bond markets, as extremely low yields at home have made overseas investments particularly attractive, with giant investors such as pension funds buying safe government debt.
Overseas bond holdings by Japanese institutional buyers peaked at $3 trillion at the end of 2020, according to data from the IMF.
But as Japanese buyers have started to return home, their global bond purchases have shrunk to just $15 billion in total over the past five years – a far cry from the roughly $500 billion in purchases they made domestically in the previous five years. Japanese bonds, which were quite unattractive to domestic investors in the past, are more attractive now. This is a “structural change” for the debt market, which risks fatally damaging the Eurozone.
