Bond bulls hoping Japan’s deep-pocketed investors can arrest the global debt rout are in for a surprise — they are furious sellers, to a degree that’s causing problems for crucial parts of the market’s plumbing.
Japanese funds sold a record $34 billion of foreign bonds in the two weeks ended Feb. 26 as the nation’s fiscal year-end in March approaches — enough to cause reverberations in U.S. repurchase markets for 10-year Treasuries.
What started out as a re-balancing of books by Japanese funds has added to the volatility in global markets, with Treasury yields rocketing to levels seen before the pandemic, as a vicious cycle unfolds as selling begets more sales. The dumping from Japan, one of the biggest owners of debt, triggers hedging by dealers on the other side of the trade, which in turn impacts crucial funding markets relying on bonds as collateral.
Yen-based investors have been liquidating so-called older Treasury positions, according to traders in Asia, who asked not to be identified as they aren’t authorized to speak publicly. After four straight weeks of losses in U.S. sovereign debt last month, the investors are often selling at a loss, albeit one that is offset by profits from the equity market, added one of the traders.
The impact in the repo market comes from how dealers absorbing the Japanese supply in old bonds — those not used in benchmarks — often short current ones to hedge their positions.
The dropoff in liquidity has seen dealers opt for the more-liquid current 10-year Treasury — where borrowing costs hit as low as minus 4% on Wednesday — highlighting a significant short position in the bonds, while the general collateral repo rate closed at 0.03%.
That means the investor lending out cash for the 10-year bonds ends up having to pay, instead of getting compensated.
Market commentators had speculated that Japanese investors would be attracted to global bonds during the selloff given the higher yields.
Japan’s investors are the largest foreign holders of U.S. government bonds. They sold a net $17.8 billion of Treasury bonds last year, based on official U.S. data.
The selling from Japanese funds are “likely to continue” as long as there is no warning from U.S. officials about the recent rapid pace of increase in yields, said Shinji Kunibe, head of global fixed-income group at Sumitomo Mitsui DS Asset.
There may be some relief for repo markets soon. The U.S. Treasury will reopen the 10-year bond next week, with the size of the sale to be announced on Thursday, an increase in supply which could help alleviate the pressure.
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