It's not AI, nor war—what US stocks should be most worried about is Japan.

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Global markets are underestimating a potential systemic risk—Japan. As the yen falls to multi-decade lows and domestic assets gain appeal, the world's largest pension fund is facing policy pressure to reallocate assets back to Japan. Once this process begins, U.S. stocks, bonds, and the dollar may all come under simultaneous pressure.

Recently, Japanese Prime Minister Sanae Takaichi stated that the government will push the Government Pension Investment Fund (GPIF) and other national pension funds to increase investment in Japanese domestic financial assets. Finance Minister Katsuki Katayama had previously sent similar signals. Although GPIF has yet to announce any formal asset allocation changes, the market is already assessing its potential impact: if the fund repatriates overseas holdings, U.S. Treasury yields may rise, the dollar may weaken, and risk assets could face pressure.

Currently, markets are still relatively calm in pricing this risk, but some technical indicators are showing subtle changes. Investors should stay alert.

$1.8 Trillion Variable

GPIF manages about $1.8 trillion, with domestic and overseas assets each accounting for roughly half, and overseas holdings totaling about $930 billion. In recent years, GPIF's holdings of Japanese government bonds have fallen from about $770 billion to $515 billion, while its foreign bond holdings have risen from about $128 billion to $470 billion.

This structural change means that even minor reallocation of assets could trigger significant volatility in global markets. According to MarketWatch, analyst Michael Kramer pointed out, if GPIF brings some overseas assets back domestically, it will directly boost demand for the yen and introduce large-scale buying into the Japanese government bond market—which is positive for Japan but implies higher interest rates and a weaker dollar for the U.S.

At the same time, if massive unwindings of yen carry trades (borrowing low-interest yen, swapping for dollars, then investing in U.S. assets) occur, risk assets will be further suppressed.

Yen and JGBs: Rising Domestic Asset Appeal

The driving force behind GPIF’s potential reallocation is the substantial improvement in the fundamentals of Japanese domestic assets. As Japanese inflation rises and economic growth recovers, attractive domestic investment opportunities are increasing. As of February, the U.S.-Japan 2-year government bond yield spread narrowed to the lowest point since early 2022.

Meanwhile, the yen continues to weaken, with USD/JPY breaking 163, the highest level since 1986. From a technical perspective, if the rate rises further, the next resistance is near 176. According to the Financial Times, Neuberger Berman’s Fredrik Repton believes that if GPIF allocates more funds to domestic assets, it could be a “very elegant solution” to Japan’s macro issues, but other domestic financial institutions need to follow, and “this process will take a long time.”

Japanese 10-year government bond yields recently hit 2.7%, the first time in 30 years. Deutsche Bank analyst Mallika Sachdeva noted in a recent report that Japanese policymakers may be shifting focus from managing exchange rates to yield management. If this shift materializes, the yen will be further pressured.

Markets Not Yet Priced In, Signals Emerging

At present, global markets remain relatively restrained in response to the risk of Japanese capital repatriation. The 5-year USD/JPY cross-currency basis swap recently hovered around negative 30 basis points—the narrowest level since the series was launched in 2021—indicating that demand for hedging yen appreciation is not yet obvious.

However, this indicator itself is a key signal for tracking whether capital flow directions are changing. Historically, the S&P 500 Index and the cross-currency basis swap have often moved in tandem—whenever hedging demand surges, U.S. stocks tend to fall as liquidity tightens. Once the market anticipates higher yen appreciation, dollar hedging demand will climb, and liquidity tightening effects will be more pronounced.

Japanese Stock Market: Another Side Beyond Risk

Notably, GPIF’s potential reallocation may pressure U.S. markets, but it also gives Japan’s stock market a new narrative. Japanese stocks are benefiting from drivers markedly different from the U.S.: the Topix index’s tech sector concentration is much lower than the S&P 500, AI exposure is limited, and valuations are still over 20% discounted compared to the S&P 500.

Corporate governance reform is the core catalyst for Japanese stocks. Dan Rasmussen of Verdad Advisers pointed out that there are still around 1,000 Japanese companies trading below book value; among the cheapest fifth of companies, cross-shareholdings still account for about 40% of market cap. As cross-shareholdings unwind, significant accumulated profits could be released—substantially boosting corporate earnings.

However, for overseas investors, the persistently weak yen is the biggest obstacle—in the past two years, yen depreciation has significantly eroded foreigners’ actual returns in Japanese stocks. How to handle exchange rate hedging, and whether hedging costs are bearable, remain core questions for global investors.

Risk Warning and DisclaimerMarkets are risky; investment needs caution. This article does not constitute personal investment advice, nor does it take account of individual users' special investment objectives, financial situations, or needs. Users should consider whether any opinions, views, or conclusions in this article fit their specific circumstances. Invest accordingly, and you are responsible for your own decisions. ```