Unhedgemon
The fate of Japan’s $6trn foreign portfolio rattles global markets
The knock-on effects of a sell-off in Japanese-held foreign investments would be far-reaching
JAPAN IS A global investment colossus.
Its financial institutions hold $6trn-worth in foreign securities, a figure which has doubled in the past 20 years as rock-bottom interest rates and a weak yen depressed domestic returns.
Half of this is tied up in American assets and another fifth in the Cayman Islands, chiefly as a conduit for more American investments.
What would happen if Japanese investors suddenly pulled their money back home?
The question is no longer hypothetical.
On January 20th the yield on Japan’s 30-year government bond hit 3.8%, the highest in its quarter-century history, as the market digested scenarios for a snap election called for February 8th, which may bolster a free-spending government.
In recent weeks Scott Bessent, America’s treasury secretary, has blamed ructions in Japanese markets for a rise in America’s borrowing costs.
Research suggests that if foreigners sold $140bn more in Treasuries than they do in a typical month, yields across maturities might rise by about half a percentage point in the short run.
For Japanese investors this would mean dumping 12% of their Treasuries, or the equivalent of 2% of their foreign securities.
Such a scenario is unlikely outside a full-blown financial panic. But it has become a bit less improbable than it used to be.
The reason has to do with the changing nature of Japanese foreign investments.
In the past, many of these were hedged using currency swaps, to safeguard returns in yen terms in the event of a weakening dollar.
The price of such swaps reflects the difference in short-term interest rates between two countries.
The smaller the difference, the cheaper the hedge.
When Japanese and American rates were both near zero, Japanese investors with a taste for hedging, such as life insurers, ate up foreign assets.
As inflation picked up after the covid-19 pandemic, and American short-term rates jumped higher than Japanese ones, currency swaps became prohibitively expensive and those investors lost their appetite for investments abroad—and for hedging those they retained.
Between 2021 and 2024 Japan’s life insurers went from protecting 60% of their foreign bond holdings to just 40%.
More important, even as hedged Japanese investors reduced their foreign exposure, those that typically eschewed hedging in the first place, like pension funds and investment trusts, were increasing it.
Non-Japanese bonds and shares make up half of all assets held by the $1.8trn Government Pension Investment Fund (GPIF), for example, up from 22% in 2012.
The trusts, which have grown popular with households since a law in 2014 gave them a favourable tax treatment, hold $1.3trn in foreign securities, mostly American stocks.
The flipside of being unhedged is greater sensitivity to rising interest rates at home—and to a stronger yen.
If today’s hedgeless investors dump foreign assets and pile into domestic ones, the currency would appreciate.
This would make repatriation more attractive, accelerating the sell-off in foreign securities.
Such a spiral is not inevitable; Japanese 30-year yields have come down from their peak in the past week.
But nor is Japan’s insatiable demand for foreign assets.
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