The Bank of Japan’s shock decision to introduce negative interest rates in January 2016 sparked a shift in investor demand for Japanese debt — while domestic Japanese investors dumped shorter dated domestic credit and looked overseas for yield, international buyers have flocked to the country in increasing numbers.
Tatsuya Yasuda, head of international debt capital markets at Nomura, says this is unusual from a historical perspective, but the impact of monetary easing is forcing investors into markets they might not previously have considered.
“We haven’t traditionally seen much activity,” he says. “But yen [bonds] are just one of the products that such investors are now keen to look at, because they have so much cash in their pockets.”
With the US raising interest rates, while Japan keeps its own firmly negative, swapping short dated yen paper back into dollars creates an attractive return, even when buying negative yielding Japanese debt. That is helping international buyers to muscle out Japan’s own investors.
“More and more foreign investors are attracted to Japanese bonds, including asset managers in the US,” says Ryohei Matsumoto, assistant director in the treasury department at the Development Bank of Japan (DBJ).
Swapped back into dollars, negative yielding Japanese government bonds (JGBs) offer foreign investors a return that domestic investors can’t take advantage of.
“Even if foreign investors buy negative yielding products in yen, they can still get a decent spread over Libor when they swap it back to dollars, and that is driving investor interest,” says Akihiro Igarashi, executive director in debt syndicate at Nomura.
Foreign buyers at the short end of the JGB curve are to some extent supplanting the reduction in exposure sought by Japanese institutional investors, although as a proportion, foreign buyers still account for fewer holdings than domestic bank and insurance companies.
According to the Ministry of Finance’s review of the 2016 fiscal year, domestic banks’ holdings fell, while insurers’ holdings levelled off. Meanwhile, foreign investors’ JGB holdings “moderately increased” to 10.2% of the outstanding market. Their T-Bill holdings were even higher, accounting for 49% of the market.
Broadening horizons
The search for higher yields is also pushing these foreign buyers outside of the comfort of government debt, and into agency and corporate names.
“Buyers are switching into SSA names away from Japanese government bonds, because they offer similar credit risk but with more yield,” says Masanori Kazama, vice-president of debt capital markets at Nomura in Tokyo.
“In terms of yen-denominated issues, some investors can take advantage of the spread available at the shorter end of the maturity curve. Although Japanese government bonds have negative interest rates, non-government bonds are being issued with zero coupons, or slightly positive, which offers some spread,” says Matsumoto.
Keiichiro Taguchi, syndicate associate at Nomura, says: “Investors are looking at short and medium duration. We haven’t seen strong demand in longer tenors such as 10 or 20 year paper because they don’t want to take this kind of duration risk in yen.”
Taguchi adds: “It’s a similar picture in corporate debt for non-Japanese investors, with foreign buyers looking at three to five year paper in blue chip companies.”
Some traditional JGB buyers are looking at agency paper for the extra yield. But poor liquidity and a lack of availability of government debt is also a factor, says Nomura’s Igarashi.
“Many investors have also been crowded out of the JGB market because of the Bank of Japan purchase programme, so even if they wanted to buy JGBs there isn’t much available in the market to buy, so they have had to look for other products,” he says.
Analysts at Bank of America Merrill Lynch agreed in recent research reports in March and February, highlighting how JGB liquidity has “withered” as a result of the Bank of Japan’s buying programme. In January, domestic financial institutions traded the lowest volume of interest bearing JGBs since April 2004, the analysts said, while also pointing out that net purchasing by foreign buyers has occurred for 31 months before January.
An island of stability
Technical factors and relative value are not the only reasons why overseas investors might be increasingly drawn to the Japanese market though.
The unpredictability of politics in the US and across Europe has made the stable government of Japan’s prime minister, Shinzo Abe — one of the country’s longest serving in recent memory — a clear attraction.
“There has been a lot of political uncertainty in the US and Europe over the past two years,” says Matsumoto. “On the other hand, the Japanese political situation is relatively stable so some investors are looking at Japanese names based on that.”
The economic outlook is also appealing, he says, despite Standard & Poor’s decision to downgrade the country’s sovereign debt by one notch from AA- to A+ in 2015. The ratings agency blamed a slowing economy, low inflation levels and a high debt-to-GDP ratio. The downgrade followed similar moves from Moody’s and Fitch.
“The reality is that when the world becomes ‘risk-off’ investors come to Japan,” says Matsumoto. “Overseas buyers might consider Japanese bonds reasonable because of that.
“We feel the economy is recovering slightly,” he adds. “It’s totally different now compared to five years ago. I think prime minister Abe’s economic reforms need more time to be implemented but most people in Japan think our cabinet is moving in the right direction.”
Tempered optimism
Bankers are careful not to get carried away with the scale of foreign investor demand for Japanese credit. There are still clear hurdles to entering the market, which limit their involvement.
One factor is that foreign investors in corporate debt tend to be drawn to Japanese blue-chip companies, but such issuers often satisfy their demand by issuing in foreign currencies.
“Some of these bigger companies, such as Toyota, issue frequently in dollar or euro markets via their subsidiaries, which international buyers are happy with to get exposure to the credit,” says Kazama of Nomura.
Meanwhile, smaller companies, often unfamiliar to foreign investors, have little incentive to reach out beyond the strong domestic demand for their yen bonds, he adds. International investors’ frequent need for a credit rating from one of the big three international rating agencies, which such borrowers generally lack, also stymies the flow of funds from overseas.
Kazama is careful not to overemphasise the role that foreign investors are playing in the Japanese domestic market, even if greater interest has been noted, because of the strength of local demand.
“Even for some SSA issuers that only issue in yen,” he says, “they go to visit overseas investors on occasion, but it’s not a regular activity. They have the home market to themselves.”
But those borrowers are stepping up their international investor relations efforts. “Compared to previous years they are doing a little bit more in terms of marketing to foreign investors,” he adds.
One interesting development, however, is that increasingly, those marketing efforts are taking place closer to home compared to the European and US asset managers that Japanese issuers have traditionally targeted.
“[The] trend is shifting towards Asian investors who are often more familiar with the credit,” he says. “Issuers are tending to visit key Asian financial cities such as Hong Kong and Singapore more regularly.”
The factors driving this trend are, however, similar to the forces driving European and US investors to Japanese credit — the effect of several years of monetary easing.
“The excess cash being poured into the market by quantitative easing in China or East Asia is having a similar effect as other regions with similar monetary policies,’ says Kazama. “Investors have cash at their disposal that they need to invest.”