Japan is selling France and Italy – RBS

Research Team at RBS, notes that in June, Japanese investors shed EUR sovereigns to the tune of €2.6bn and while the trend in bunds is hardly surprising and in line with a long-term trend, the shedding of French and Italian sovereign paper is more surprising: this is the first negative reading of 2016.

Key Quotes

“This could be explained by (i) concerns in the run-up to the UK referendum or (ii) seasonal patterns (in Jun-15 Japanese investors sold €9.1bn, dwarfing this year’s €1.7bn). The July JGB sell-off should make foreign bonds comparably less attractive. However, such trends can be reversed by the sharp appreciation of the EURJPY basis. The 5y basis was as low as -52 at the beginning of June: it now trades at -36.

Cheaper hedge mitigates the effect of JGBs cheapening…

Indeed, if a Japanese investor were to fully hedge via matched maturity cross-currency basis swap, it wouldn’t generate any pick up in most instruments. In the EUR sovereign space the only instruments offering a pick-up to JGBs are 30y semi-core bonds or peripheral paper. Generally speaking, EUR paper has become materially less attractive, in particular since the JGB sell-off of late July.

… but Japanese investors are increasingly likely to opt for short-term hedges

The deterioration in returns of foreign paper post-hedge is likely to push Japanese investors to undertake an increasing number of purchases on an either unhedged or partially hedged basis. We estimate that as little as 30% of purchases of foreign bonds is fully hedged – the majority of the rest being bought with a 1y or 3m hedge.

Japanese investors remain steady in their commitment to Treasuries…

USTs remain the instrument of choice of Japanese investors, despite the fact that all USTs offer no pick-up to JGBs if maturity-matching the basis hedge: in the last 12 months Japanese investors have been net Treasuries buyers to the tune of $160bn. If anything, the pace has picked up again in June after lower figures in April and May.

…. but are increasingly charmed by the SGB market

The other eye-figure catching is Sweden. After a few years of net sales, the trend seems to have changed since Aug-15, and Japanese have been buyers of SGBs. In the first half of 2016 alone, net purchases amounted to SEK15.5bn. These are meaningful flows if we take into account that there are SEK597bn outstanding in nominal bonds (and SEK171bn in linkers), with the Riksbank already owning about a third of the nominal market (and aiming to own 37% by the end of the year).”