Global Market: Japanese investors eye home assets as rising bond yields alter returns

The flow of Japanese money back into domestic assets has begun to gather pace, but uncertainty over how high local bond yields will rise and how far the Bank of Japan may lift interest rates is keeping a much larger repatriation of overseas assets on hold, according to a report by Reuters.

The Bank of Japan may have done enough for now to curb speculative bets against the yen after raising interest rates last week, signalling a focus on inflation and reportedly conducting a rate check in the foreign exchange market, the report stated.

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However, major investors remain cautious about increasing allocations to Japanese bonds while yields continue to rise and policymakers provide limited guidance on the eventual level of interest rates. Two dovish dissenting votes at the BOJ's latest meeting, along with another selloff in the bond market this week, have added to the uncertainty.

The hesitation is slowing the return of Japanese capital from overseas markets, leaving one of the world's largest pools of foreign assets largely invested abroad and limiting the potential for a sustained yen recovery that could have broader implications for global financial markets.

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Deutsche Bank fixed-income strategist Shoki Omori said the unwinding of fast-money carry trades had largely taken place, while longer-term Japanese investors such as pension funds and households had yet to make significant shifts back into domestic assets, according to Reuters.

The yen has surrendered most of its gains from early September and was trading near 159 per dollar on Friday, close to the 157 level that was the median six-month forecast among analysts surveyed by Reuters earlier this month.

The currency is down about 1% so far this year, although it fell to nearly 164 per dollar in July, its weakest level in almost four decades, the report stated.

Speculative positioning has meanwhile shifted sharply. Data showed short sellers had retreated alongside the yen's decline, with speculative positions switching from a large net short to the biggest net long position since July 2025. Net long positions reached $9.7 billion in the first two weeks of September, according to Reuters.

Another obstacle for the yen is that major central banks have also moved towards higher interest rates in response to inflationary pressures linked to the Middle East conflict. That suggests interest-rate differentials between Japan and other major economies may not narrow rapidly.

Rising JGB yields alter investment calculations

The shift in Japan's bond market is changing the relative attractiveness of domestic and overseas assets. Benchmark 10-year Japanese government bond yields have climbed by about two percentage points in less than two years, reaching above 3% and their highest level in three decades, according to the report.

According to Deutsche Bank's Omori, once currency-hedging costs are taken into account, US Treasury investments offer Japanese investors less attractive returns than domestic bonds.

Japanese investors purchased 4.8 trillion yen of sovereign debt in August, the largest net purchase in three months, according to Barclays' analysis of data from the Japan Securities Dealers Association cited by Reuters. Banks and insurers were among the buyers.

Japanese banks have also been reducing their foreign bond holdings. HSBC estimates they have sold about $70 billion of overseas bonds this year, compared with purchases of $35 billion last year, a shift that has affected bond markets from Europe to Australia.

Life insurers, which hold 438.6 trillion yen ($2.78 trillion) in assets, represent another potentially significant source of repatriation. However, the pace and scale of any shift by the sector remain difficult to determine from the broad portfolio data published by the Life Insurance Association of Japan.

State Street Global Advisors senior portfolio manager Aaron Hurd said Japanese repatriation remained at an early stage and could accelerate once investors gain greater confidence that domestic bond yields have reached their peak, Reuters reported.

GPIF could trigger wider domestic allocation shift

The pace of repatriation could increase if Japan's largest institutional investors make a more decisive shift towards domestic assets.

Japan's finance minister has encouraged the $1.8 trillion Government Pension Investment Fund, or GPIF, to increase its allocation to domestic markets. Analysts cited by Reuters said a formal move by the fund could prompt other Japanese institutional investors to reassess their portfolios.

Pioneer Investments director of market strategy Paresh Upadhyaya said a confirmed increase in the GPIF's domestic Japanese government bond allocation could pressure other domestic investors to follow suit, according to Reuters.

Still, rising US Treasury yields and expectations of further Federal Reserve tightening could make it difficult for the BOJ to narrow the interest-rate gap sufficiently to drive a sustained yen rally.

Nomura Securities chief macro strategist Naka Matsuzawa said greater clarity from Japanese life insurers on the end of the BOJ's rate-normalisation cycle would be important for stronger repatriation flows.

For now, Japanese investors appear to be waiting for clearer evidence that domestic yields have peaked before making a much larger shift from overseas assets back into Japan.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)