Selling US Treasuries, buying Japanese bonds—Wall Street prepares for "repatriation of Japanese capital"

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Japan’s government bond market is undergoing dramatic changes unseen in decades, prompting global asset managers to reconsider a long-neglected risk: Will Japanese investors, who hold about $1 trillion in U.S. Treasuries, repatriate their funds?

According to the latest report from the Financial Times, several investment institutions have begun preparing for a large-scale return of Japanese capital, betting that Japanese investors will gradually sell U.S. Treasuries and instead buy Japanese government bonds (JGBs) with rising yields.

Japanese bond yields soar, hitting decades-highs

On Friday, Japan’s 10-year benchmark government bond yield rose intraday to 2.73%, the highest level since May 1997.

The 30-year JGB yield broke above 4% for the first time—the first time this maturity has hit such a level since it was first issued in 1999. The yields on 5-year and 20-year government bonds also set new historical records earlier this week.

Japan’s Finance Minister Satsuki Katayama told reporters on Friday that government bond yields in all major markets are rising: “These dynamics interact with each other, producing a compounding effect.”

Analysts expect Japanese bond yields will continue to climb. Last December, the Bank of Japan raised its policy rate to 0.75%, the highest in thirty years, and the market generally expects another 25 basis point hike to 1% in June.

The logic behind $1 trillion “repatriation”

To understand these bets, it’s necessary to first understand why Japanese investors hold such large assets abroad.

For decades, Japan maintained ultra-low interest rates, with domestic bonds offering almost no returns. To seek yields, Japanese insurers, pensions, and banks invested heavily overseas, buying U.S. Treasuries, European bonds, and a variety of global assets.

Currently, Japanese investors hold about $1 trillion in U.S. Treasuries, making Japan the largest foreign holder by far.

Now, with Japanese bond yields rising sharply, this logic is reversing. Mark Dowding, Chief Investment Officer at UK asset manager BlueBay, pointed out this shift directly. BlueBay launched its first Japan bond fund in March this year.

Dowding said: “New funds will no longer be allocated overseas. They won’t flow into U.S. corporate bonds or U.S. Treasuries, but will return to domestic Japanese investments.”

Funds have already begun a trickling return

Data shows signs of capital returning home, though still at a small scale.

According to EPFR, a fund monitor, net inflows to Japanese sovereign bond funds reached about $700 million in March, the largest single-month inflow on record for the category. The net inflow in April was $86 million, returning to more normal recent levels.

Ruffer fund manager Matt Smith is even more direct: “Pressure is building—domestic long-term yields continue to rise, and the institutional signal is ‘please bring money back to Japan.’ We think yen appreciation will occur slowly first, then accelerate abruptly.”

Smith also said that Ruffer currently holds a long yen position, using it as a core hedging tool: “Once market turbulence occurs, especially centered on the U.S. credit market, Japanese investors will bring capital back home, and the yen will appreciate.”

Repatriation yet to occur on a large scale; Japanese bonds also have risks

However, analysts caution that Japanese institutional investors are still net buyers of foreign bonds at the moment.

RBC Capital Markets Asia Macro Strategist Abbas Keshvani noted that though Japanese bond yields have “apparently offered investors better compensation,” Japanese investors have still net bought about $50 billion in foreign bonds over the past 12 months.

The reason lies in the uncertainty of Japan’s own bond market. Prime Minister Sanae Takashi won the election in February, pledging to expand government spending and subsidize inflation pressures. Increasingly, analysts warn the government will be forced to draft a supplementary budget later this year, further depressing bond prices and pushing yields higher.

Keshvani said: “Both supply and demand dynamics point to yields continuing to rise. As an investor, if you know yields will keep rising, it’s difficult to feel like buying now.”

Previously, the Bank of Japan was the market’s most important buyer, purchasing large volumes of JGBs through quantitative easing and yield curve control policies. As the Bank gradually exits, the market is reverting to traditional supply and demand, leading to much higher price volatility for Japanese bonds.

What it means for the U.S. Treasury market

The potential scale of Japanese capital repatriation means the U.S. Treasury market must take this risk seriously.

Japan is the largest foreign holder of U.S. Treasuries, with holdings around $1 trillion. Once Japanese institutional investors begin systematic selling, the impact on the supply and demand structure of U.S. Treasuries will be substantial.

Currently, Wall Street’s bets are more of a forward-looking adjustment than a reaction to something already happening. But as JGB yields continue to rise—analysts see 3% for the 10-year yield as a realistic target later this year—the logic behind these bets will become even clearer.

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