On April 4th the Bank of Japan announced a new quantitative easing program with the stated goal of doubling their monetary base and achieving 2% inflation by purchasing 75 billion US dollar equivalent of Japanese Government Bonds (JGBs) per month. Almost immediately, the global investment community came to the conclusion that this program would finally force domestic Japanese investors out of JGBs and into higher yielding global alternatives. A Japanese ‘wall of money’ was set to hit global fixed income markets.
Investors reacted accordingly. The two week period following the Bank of Japan (BOJ) announcement saw fast money investors waving in fixed income products with both hands. Offers were lifted aggressively in every market with little regard for the asset’s position on the risk spectrum. One problem…Japanese investors were not participating in this flow! In fact, they were selling into the bid created by fast money. How clever!
At the time, we watched from the diversified solutions desk with a bit of skepticism. Our work suggested that Japanese institutional investors would be a bit slower to act, and their trading activity would be much more opportunistic in nature. Japanese institutional investors have historically shown discipline in their execution, preferring to set a price target (or a yield differential) and letting the market come to them. Typically, their largest shifts out of JGBs and into non-Yen fixed income have come when local yields are near recent lows, or yield differentials are near recent wides; but market conditions throughout the month of April did not fit these conditions.
We believe that the volatility in global fixed income markets during May and June was a direct result of the poor positioning created by the aforementioned rush to purchase non-Yen fixed income. The poor positioning acted as the dry powder and Ben Bernanke’s testimony to congress provided the match which set the entire market ablaze. The resulting global fixed income sell off sent three month total returns negative in most markets despite the large positive performance in April. In some markets, like local currency EM, this series of events set off a negative feedback loop causing rates to spike to one year highs.
Where does this leave us today? We would argue that current market conditions play right into the hands of the Japanese institutional investor. Most of them have carried out their annual investment policy meetings, and the decision to tactically increase non-Yen holdings has been made. The relative stabilization of JGB yields combined with the back up in global rates markets has created an environment conducive to switching out of JGBs and adding non-Yen fixed income. Given current market conditions, we would expect to see the flow of Japanese investors into non-Yen fixed income pick up in the coming weeks. In fact, the Japanese Ministry of Finance has recently reported* that Japanese major resident investors have turned net buyers of non-Yen fixed income for the first month since January. While this flow alone may not prove large enough or aggressive enough to reverse the recent selloff, it certainly adds to the case for sticking with global fixed income going forward.