Japanese Purchases Of US Treasurys Tumble

In the last days of 2017, we showed something surprising: as a result of suddenly exploding USDJPY funding costs, there had never been a worse time for Japanese investors, traditionally some of the most ravenous purchasers of US paper, to buy US Treasurys.

As we explained on December 27, USD funding costs for Japanese insurers and banks to invest in US Treasuries - which had surged reaching a post-financial-crisis high of 2.35% on 15 Dec - are determined by three things, namely (1) the difference in US and Japanese risk-free rates (OIS), (2) the difference in US and Japanese interbank risk premiums (Libor-OIS), and (3) basis swaps, which illustrate the imbalance in currency-hedged US and Japanese investments.

In this particular case, widening of (1) as a result of Fed rate hikes and tightening of dollar funding conditions inside the US (2) and outside the US (3) have occurred simultaneously. This is shown in the chart below.

Whatever the cause behind these sharp funding shortages, one thing was clear - dollar funding costs (FX hedging costs) for both Japanese insurers, banks and other investors to buy US Treasuries were surging (with Japanese buyers and reached a post-financial-crisis high of 2.35% on 15 Dec. And in terms of practical implications for the treasury market this means that, all else equal, marginal demand for US paper is about to plunge for one simple reason: the FX-hedged yields on US Treasurys have plunged to (negative) levels never seen before (unless of course foreign investors buy US Treasurys unhedged).

To demonstrate this point, the chart below from Deutsche Bank shows the yields on currency-hedged US Treasuries from the perspective of Japanese investors. Annualized hedge costs had risen to 2.33% at the end of December, which means that investments in 10y US Treasuries would result in virtually no yield. Furthermore, yields from investment in shorter than 10y US Treasuries would be less than JGBs and result in negative spreads.

And while TSY funding costs, and various X-CCY basis swaps in the past two weeks has dropped, Japan's lack of appetite for US Treasurys will only continue to rise.

The reason is that as the Nikkei reports, Japanese investors - traditionally the most enthusiastic foreign buyers of US Treasurys - have become far less enthusiastic about buying US debt last year on growing concern about rising U.S. Treasury yields. According to Ministry of Finance data released on Friday, Japanese investors' net purchases of mid- to long-term foreign bonds tumbled 94.6% on the year to 1.1 trillion yen ($9.9 billion) in 2017, the first annual decline in four years.



In prior years, Japanese institutional investors such as banks and life insurance companies had actively pursued foreign bonds in search of higher returns, finding few alternatives in Japan, where interest rates remained extremely low, and Europe providing few options as a result of the ECB's NIRP policies. As a result, the only option for many was US paper.

But the November 2016 election of Donald Trump as U.S. president sent the 10-year Treasury yield shooting up from around 1.8% to almost 2.6% in just over a month, and the yield stayed above 2% throughout 2017. Any investors holding onto Treasurys during the yield surge would have incurred significant losses as prices tumbled.

Life insurers' net purchases declined 8.4 trillion yen last year, and banks collectively turned into net sellers, with their net sales reaching a record 7.6 trillion yen. Over 2015 and 2016, in contrast, they bought 20.6 trillion yen more than they sold.

In March 2017, Japan's Financial Services Agency announced stricter oversight on foreign bond investment by regional banks. The following month, net sales of mid- to long-term bonds by Japanese investors hit a monthly record of 4.2 trillion yen.

And, of course, as discussed at the top, the higher cost of buying the U.S. dollar is also at play. Life insurers often hedge against a strengthening yen via foreign exchange swaps when investing in foreign bonds. But hedges have become more expensive due to higher U.S. interest rates and other reasons. So the appeal of investing in U.S. bonds has faded overall, unless of course, Japanese investors bid up US paper unhedge, which however could backfire dangerously should FX volatility pick up, or if the dollar continues to devalue against most G-10 peers.

The bottom line: foreign, and certainly Japanese demand for US Treasurys appears to be sliding, whether due to rising yields and P&L losses, or blowing out funding costs, at the worst possible time: just as net supply of US Treasurys is set to double from $488BN in 2017...

... to $1,030BN in 2018, as Goldman calculated last Friday.

Which means that just one hiccup, and yields will soar. It also means that we are one not so major bond tantrum away from the Fed begging preparations for the next massive bond monetization episode, also known as QE4.


TeethVillage88s Sun, 01/14/2018 - 22:07 Permalink

Are you talking about Holdings?

Or Purchases? Seems more like holdings.

"apanese investors' net purchases of foreign bonds nosedived 94.6% on the year to 1.1 trillion yen ($9.9 billion) in 2017, the Finance Ministry reported on Friday, the first annual decline in four years."

Catullus Sun, 01/14/2018 - 22:07 Permalink

This is the other side of the Fed’s Coffin Corner. They can’t continue to print and they can’t slow down the bond purchases. 

Next the Fed will start underwriting FX Swaps

TeethVillage88s Catullus Sun, 01/14/2018 - 22:27 Permalink

It is Asymmetric Warfare... more than Pentagon.

More than 5-6 Sides. Stealth Tax = Inflation. Monetary & Fiscal Policy = Inflation. 98 Different Types of taxes & fees. Massive Printing of Dollars. Massive saturation of dollars around the world ti increase RISK. What else? Shitty US Produce & Fruit in Restaurants. Shitty Quality in Retail, Restaurants, Imports... all drag down USA Quality of Life. Destruction of Pensions. Destruction of Bread Winner Jobs. Expensive Health Care & Education. Expensive Housing, Utilities, Taxes on Rents,... fug.

In reply to by Catullus

spdrdr Sun, 01/14/2018 - 22:07 Permalink

OK, so what does this all mean to a layman?

SURE, the bond markets are (what, 5x?) larger than the stock markets.

What can possibly go wrong here?

dirty fingernails Sun, 01/14/2018 - 22:11 Permalink

I forsee Belgium going in in a big way. Record sales every.single.time. Until someone big loudly asks "Who is buying because we don't know anyone who is, could be, should be, or would be.

wisehiney Sun, 01/14/2018 - 22:11 Permalink


More treasury yield.

So much fun to convert .gov interest payments into precious.

Every month.

FOMC despises paying interest to savers.

Fuck y'all, pay up!

TeethVillage88s wisehiney Sun, 01/14/2018 - 22:21 Permalink

If you bought discounted US Treasuries... 10-30 year... I think you could get 2.56% yield... the other guy takes a bath. But maybe I don't know whit. I saw 3-10 year US Notes or US Treasuries listed as 7.5% or 8% on a brokerage website. So... you have to buy volume, like a small tranche of $10,000 maybe... but I think there is more to it. Maybe you have to pay a fee, then pay a discount rate also....

"They Fuck Ya, They Fuck Ya. They Fuck Ya."

In reply to by wisehiney

TeethVillage88s Sun, 01/14/2018 - 22:12 Permalink

Total Current Account Balance for the United States (BPBLTT01USA637S) 2006 = - $800 Billion?

Interesting of the $26 Trillion in Foreign Owned US Assets put out by BEA.GOV on IIP Data, looks like about half is accounted for in the 2013 Data Report as Equities, LT Corporate Debt, LT Agency Debt, LT Treasuries. Which leaves me to conclude foreign owned US Real Estate must be about $12-14 Trillion (page 30). But I am not an Economist or Financial guy. Maybe Europeans are also buying US Real Estate.

http://www.treasury.gov/ticdata/Publish/shl2002r.pdf (short term & Long term investments in Treasuries and Stocks)

Rest of the world; foreign direct investment in U.S.; asset, Level
2014:Q1: 3,249,001.2 Millions of Dollars (+ see more)
Quarterly, Not Seasonally Adjusted, ROWFDNQ027S, Updated: 2014-06-05


Gross Private Domestic Investment
2014:Q2: 2,829.3 Billions of Dollars (+ see more)
Quarterly, Seasonally Adjusted Annual Rate, GPDI, Updated: 2014-07-30

Ah I have Table I developed on Foreign investment in US Assets (Property) but it is a bit out of date.

Not sure whether to post it. It is TIC Data, by Country, By Date, By Asset Class... usually just Treasuries are what I post.

JibjeResearch Sun, 01/14/2018 - 22:23 Permalink

Moving forward, holding the USD's bond is not the best option.  The Euro and Yuan will be stronger in the future.

The USD, Euro, Yuan are the important three fiats.

turkey george palmer Mon, 01/15/2018 - 01:42 Permalink

The next shoe is 401k regulation. Naturally the S&P 500 has to drop 35%. First. Then 401k accounts will be required to invest in safe Treasuries. Maybe or maybe not .  Are the Saudis liquidating anything? Seems like they need some quick cash for anti missile defense or some such thing.

Dr.Engineer Mon, 01/15/2018 - 06:58 Permalink

This was helpful.  This article made me realize that foreign purchasers would hedge their bond buying.   This explains why someone would purchase a negatively yielding native bond -- because the foreign bond interest rate - the hedging cost was even lower.

Wow.  Things are so screwed up now.

Herdee Mon, 01/15/2018 - 07:36 Permalink

Yields will soar because the U.S. deficits are becoming higher risk with the perception that spending can't be controlled. Soon trillion dollar deficits will seem small.

fattail Mon, 01/15/2018 - 08:09 Permalink

The upcoming Government shutdown where fiscal sanity will be surrendered in the negotiations may be the  first domino to start the cascade.  The Fed is very good at changing the rules to their benefit just in the nick of time.  

You can tell how close we are to the end by the level of complexity in these ancillary measures that must be managed and monitored by the Fed.  One small fire after another.  How much water does the Fed have?

Cutter Mon, 01/15/2018 - 12:51 Permalink

This idea that "rates can't rise because we have too much debt" is pure fallacy.  It rests on the mistaken belief that all-powerful Central Banks completely control rates.  Something even Japan has recently admitted is not possible.  

When risk incentives in markets worldwide align against Central Banks' wishes, the bankers will lose.

Rates are going much higher.