Japanese investors are staying away from Europe in favour of Treasuries again
It's something of a trend that has been developing since Q4 2018 as Japanese investors look to switch money from European bonds to that of the US, as global growth slowdown and recession fears continue to grip markets.
In Europe, we're seeing bund yields fall back towards 0% while in Japan, investors are squeezed out by the fact that the BOJ basically owns half of JGBs in the bond market. That is leaving little options for investors to really find investment opportunities.
Treasuries have been shunned by Japanese investors since 2017 due to the fact that the actual cost of hedging the currency risk has continually risen thanks to the increase in Libor despite the cross-currency basis swap being relatively low:
I explained more on that in a post last year here.
So, why are Japanese investors coming back to Treasuries again if the cost related to hedging the currency risk is still high?
I reckon it could be due to the fact that investors would rather participate in potential capital gains (falling yields) offered by Treasuries and perhaps bite the bullet and leave their investment unhedged against currency risks.
From an investing perspective, there's a couple of reasons still supporting a move lower in bond yields i.e. weakening inflation, global growth slowdown (recession fears) and more dovish central banks. But the last reason is likely key to the decision here.
The ECB and BOJ are already in negative rates territory and would have limited scope for further rate cutting in the event of a global economic downturn. Whereas if you compare that to the Fed, there's plenty of room to cut rates from the current 2.25% to 2.50% range and that will allow for yields to head much lower if and when such circumstances are to arise.
With global bond market players seeking out Treasuries, it provides an indirect tailwind for the dollar in the bigger picture so this is something to consider in the medium-to-long term.
