Japan Insurer’s Plan to Sell Foreign Debt Flashes Market Warning

(Bloomberg) — A Japanese insurer with $65 billion of assets plans to offload all its currency-hedged foreign debt holdings, foreshadowing what may become a renewed wave of selling by some of the biggest investors in global bond markets.

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Fukoku Mutual Life Insurance Co. is among the first of Japan’s life insurers to lay out investment strategies for the fiscal year. With combined assets of $2.9 trillion, the industry has long been a major force in overseas markets but has pulled back in the past year as hedging costs erase the yield premium on foreign debt, and expectations rise for an end to the Bank of Japan’s ultra-loose monetary policy.

The privately-owned firm, with ¥8.8 trillion ($65 billion) of assets, will cut its holdings of offshore debt by ¥300 billion in the fiscal year started April 1, said Yoshiyuki Suzuki, executive officer and head of the investment planning department. The reduction will eliminate all its remaining ¥240 billion of hedged foreign notes.

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Last year’s surge in dollar-hedging costs for Japanese investors has eaten away most, if not all, of the returns they get from foreign sovereign debt. A 10-year Treasury bond with a yield of 3.6% has a negative return with hedging costs now at more than 5%. That’s making even low-yielding domestic debt attractive.

“It may be a different situation if we can expect hedging costs to fall in the near term,” Suzuki said. While a US rate reduction will bring down the costs, “a cut is unlikely this fiscal year even though the Fed’s tightening will probably end soon.”

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Instead, the insurer will invest ¥320 billion in Japanese debt, of which ¥270 billion will go to sovereign bonds and ¥50 billion to corporate paper, he said.

Suzuki’s comments offer an early peep into the mindset of Japanese life insurers, which sold a record amount of foreign bonds in the previous fiscal year. Big investors in anything from Treasuries to Brazilian debt, their decisions will shed light on how they’re positioning for a potential BOJ policy tweak that may reverse years of capital outflows.

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The BOJ will probably remove yield curve control this fiscal year, Suzuki said. “My personal guess is that it may abolish the YCC early with the potential for a surprise in terms of timing.”

Fukoku expects Japan’s benchmark 10-year sovereign bonds to yield 0.8% at the end of this fiscal year, above the BOJ’s 0.5% ceiling. Yields on 20-year JGBs will likely be at 1.6%, up from the current 1.095%.

“Yields at home are likely to rise slightly from here, and we will continue to invest with the yields at around the current level,” Suzuki said. “For 20- and 30-year yields, slightly above 1% is an acceptable level to buy.

Fukoku slashed a record ¥650 billion of foreign bond holdings in the fiscal year ended March. It added a record ¥470 billion of local debt in the same period.

It also expects the dollar to weaken to 125 yen by March 31, while expecting 10-year Treasury yields at around 3.4%. The Japanese currency stood around 134.50 per dollar Tuesday morning.

–With assistance from Masaki Kondo.