TLDR:
- Japanese investors are shifting focus from overseas assets to domestic bonds
- A $4.4 trillion “carry trade” of Japanese investments abroad is slowly unwinding
- The Bank of Japan’s policy changes and narrowing interest rate gaps are driving this trend
- The scale and speed of this shift could potentially disrupt global markets
- Japanese investors are major holders of various international assets, including US Treasuries
The global financial landscape is witnessing a shift as Japanese investors, long known for their overseas investments, are gradually turning their attention back to domestic markets.
This trend, often referred to as the unwinding of the “carry trade,” has the potential to reshape international asset allocations and impact markets worldwide.
For decades, Japanese investors have been major players in global financial markets, taking advantage of low interest rates at home to invest in higher-yielding assets abroad. This strategy, known as the carry trade, has led to Japanese investors holding an estimated $4.4 trillion in overseas assets – a sum larger than India’s entire economy.
However, recent data indicates a change in this long-standing trend. In the first eight months of 2024, Japanese investors purchased a net ¥28 trillion ($192 billion) of Japanese government bonds, the largest amount for this period in at least 14 years. Simultaneously, their purchases of foreign bonds nearly halved to ¥7.7 trillion, while investments in overseas equities fell below ¥1 trillion.
This shift can be attributed to several factors, primarily the changing interest rate environment. The Bank of Japan has begun to normalize its monetary policy, raising interest rates and making domestic investments more attractive.
As the yield gap between Japan and other countries narrows, the incentive for Japanese investors to seek higher returns abroad diminishes.
The potential impact of this trend on global markets is significant. Japanese investors are the largest foreign holders of U.S. government bonds and own substantial portions of debt and equity in various countries.
Any large-scale repatriation of these funds could potentially disrupt market dynamics and asset valuations worldwide.
The Bank of Japan has indicated a measured approach to policy normalization, and many large Japanese institutional investors still maintain significant overseas allocations. For instance, the Government Pension Investment Fund of Japan continues to target about half of its holdings in foreign bonds and equities.
The pace and extent of this shift will largely depend on future interest rate movements both in Japan and globally. While some Japanese insurers have indicated they would increase domestic holdings if yields on long-term Japanese government bonds rise above certain thresholds, others continue to see value in diversified international portfolios.
Market observers and financial institutions are closely monitoring this trend. Some experts view it as a “mega trend” that could persist for the next five to ten years, potentially leading to a sustained flow of capital back into Japan.
However, others caution against expectations of abrupt changes, noting that the process is likely to be gradual and influenced by various economic factors.
