Japan’s $4 Trillion Carry Trade Begins to Unwind

Japan’s massive $4 trillion carry trade is starting to unwind, as domestic investors shift their focus back to local assets. This trend marks a significant change in investment behavior, with implications for both the Japanese economy and global markets.

Key Takeaways

• Japanese investors are increasingly favoring domestic government bonds over foreign assets.
• In the first eight months of the year, they purchased a net ¥28 trillion ($192 billion) in local bonds.
• The unwinding of the carry trade could disrupt global markets, given Japan’s substantial overseas investments.

Shift in Investment Trends

Japanese investors have historically favored overseas assets, benefiting from ultra-low interest rates at home to fund purchases abroad. However, recent data indicates a shift in this trend. In 2024, Japanese investors have significantly reduced their foreign bond purchases and equities, opting instead for local government bonds.

• Net Purchases of Local Bonds: ¥28 trillion ($192 billion) in the first eight months of 2024.
• Foreign Bonds: Purchases cut by almost half to ¥7.7 trillion.
• Overseas Equities: Less than ¥1 trillion invested.

This change is being described as a mega trend that could last for the next five to ten years, as investors seek stability and better yields in their home market.

Implications for Global Markets

The scale of Japan’s overseas investments, estimated at $4.4 trillion, is larger than the entire economy of India. As Japanese investors begin to repatriate funds, the potential for market disruption increases. The unwinding of the carry trade could lead to significant volatility in global markets, especially if it occurs rapidly.

• Historical Context: The last major market disruption occurred on August 5, when fears of rising Japanese rates led to a swift unwinding of carry trade bets, causing the Nikkei 225 to experience its largest drop since 1987.
• Current Market Conditions: The Bank of Japan (BOJ) has indicated a cautious approach to rate hikes, which may influence the pace of capital repatriation.

Future Outlook

As the BOJ continues to raise rates, yields on Japanese government bonds are becoming more attractive. For instance, yields on 30-year bonds have risen above 2%, prompting some of Japan’s largest insurers to consider increasing their holdings of local debt.

• Key Yield Levels:
  • T&D Asset Management Co. suggests a yield above 2.5% could trigger significant repatriation.
  • Dai-ichi Life Insurance Co. views yields above 2% as attractive.

Despite the normalization of policy, Japan’s rates remain significantly lower than those in the US and Europe, which still attracts yield-seeking investors willing to take on currency risk.

Conclusion

The gradual unwinding of Japan’s $4 trillion carry trade signals a pivotal moment for both domestic and global markets. As Japanese investors shift their focus back to local assets, the potential for market volatility looms large. Investors and analysts alike will be closely monitoring these developments, as they could reshape investment strategies and market dynamics in the coming years.

Sources

• Japanese Investors Favor Domestic Debt Over Foreign Stocks, Bonds – Bloomberg, Bloomberg.com.