TOKYO: Foreign investors have poured into Japanese government bonds as the yield differential between Japanese and euro zone government debt shrinks and the yen continues to perform well against some currencies other than the US dollar.
Data from Japan's Ministry of Finance show that foreign investors were net buyers of long-term Japanese bonds for 12 straight weeks until the third week of September, the longest such streak since the ministry began compiling the data in 2005.
During the streak, foreigners bought 4.522 trillion yen ($41.84 billion) of yen bonds.
"Contrary to general notions that the yen has weakened significantly, it has performed well against currencies like the euro, Australian dollar and those of emerging markets," said Tadashi Matsukawa, head of fixed-income investments in PineBridge Investments in Tokyo.
Given that situation, Japanese bonds "are attractive assets for foreign buyers looking to diversify their foreign reserves amid narrowing yield differentials," he said.
While the dollar has gained 2.5 percent against the yen this year, and touched a six-year high on Oct. 1, the euro has shed 5 percent versus the Japanese currency in 2014. "Investors such as sovereign wealth funds and central banks, who tend to buy and hold, have shown steady demand for short-term Japanese debt and the yen's strength is a factor," Matsukawa said.
FALLING EUROBOND YIELDS
The strong foreign interest in JGBs has coincided with the steady decline in euro zone bond yields, with benchmark German Bund yields falling to record lows as the European Central Bank embarked on unprecedented monetary easing to stave off deflation.
After the ECB cut the interest rate on deposits at the bank to below zero on June 5, the yield on seven euro zone countries' short-term government bonds turned negative.
The spread between Japanese and German 10-year benchmark bond yields, which was 120 basis points at the start of the year, this month has tightened to 40 basis points, near the historic low.
While Bunds still yield more than JGBs, the spread could tighten even more as the ECB is widely expected to loosen policy even further. The Bank of Japan, with extensive quantitative easing already in place, has less room to manoeuvre.
At the short-end of the curve, the yield on two-year French government - which momentarily fell below zero percent in September - is below that of its JGB counterpart.
"For central banks that have to diversify their foreign reserves, the question becomes, why buy French two-year debt that offers negative yields?" said Makoto Noji, senior fixed income strategist at SMBC Nikko Securities.
REASONS TO BUY
"On the other hand, they can pick up 0.2 to 0.3 percent on two-year JGBs through swap transactions, which offer not only central banks but other investors all kinds of reasons to buy Japanese debt," he said.
Although much euro zone debt still yields more than JGBs, differentials have shrunk so much that JGBs sometimes offer a higher total level when the premium earned from asset swaps is included.
This is possible because foreign investors get a premium for using dollars or euros to purchase yen through currency swaps based on interbank rates such as Libor.
The premium, when combined with JGB yields and converted to fixed returns through interest rate swaps, gives Japanese paper yields comparable to those offered by euro zone debt.
The higher credit rating that JGBs enjoy over some euro zone counterparts such as Spanish debt is also seen spurring demand for such transactions.
Five-year JGBs may yield less than Spanish bonds but they can still be of interest to foreign investors as Japan is rated higher than Spain, Noji at SMBC Nikko Securities said.
Standard & Poor's rates Japan at AA- and Spain at BBB.
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