It looks, at first glance, like the biggest conundrum in global markets. For years foreign investors have consistently increased their holdings of Japanese government debt. Their share of this market, on which yields are minimal or negative thanks to the Bank of Japan’s quantitative easing programme, now stands at more than a tenth.
Conundrum n. 难题；谜语France has grappled with this conundrum for years. 法国就已经为了这个难题苦恼多年。
How do we explain this counter-current to the tide of de-globalisation, this enthusiasm for what must objectively be seen as one of the world’s least attractive government bond markets — especially when resident investors have been investing heavily in foreign assets since the central bank embarked on the latest round of QE in 2013? Surely, you might ask, they cannot both be right?
In fact, resident and non-resident investors are acting perfectly rationally. If the foreign flow into Japanese government bonds (JGBs) looks perverse it is because it reflects the distorting effects wrought by the divergent monetary policies operated by the Federal Reserve and the Bank of Japan on currency and bond markets as investors search for yield. The behaviour of domestic and foreign investors is intimately linked.
Wrought adj. 锻造的；加工的；精细的
Nuclear weapons have wrought a revolution in international relations. 核武器已经使国际关系发生了变革。
The starting point is that Japanese investors’ demand for dollars since 2013 has widened the so-called cross-currency basis in the currency swap market. That is the spread over the US dollar Libor interest rate when a purchase of dollars is funded via the swap market using Japanese yen.
The Bank of Japan attributes this to three main factors. The first is the divergent monetary policy referred to earlier. With the Fed tightening while the Bank of Japan (and the European Central Bank) have continued to pursue ultra-loose monetary policy there is a natural carry trade whereby yen (or euro) investors can make a profit by investing in higher-yielding US Treasuries. The transaction is hedged through the swaps market.
Also important has been the global banks’ reduced appetite for market making and arbitrage because of the tougher post-crisis capital regime. At the same time there has been a decrease in the supply of dollars from foreign reserve managers and sovereign wealth funds against the background of falling commodity prices and depreciating emerging market currencies.
To be continued...