Massive Japanese Capital Rushing into China
On August 25th, following Federal Reserve Chairman Powell's clear signal of an imminent rate cut at the Jackson Hole symposium two days prior, the Fed is swiftly backing down from its hawkish monetary stance of the past two years, which involved 11 rate hikes that brought the benchmark interest rate to a century-high of 5.25%-5.5%.
As the Fed pivots to a dovish stance, the CME FedWatch Tool predicts a 24% chance of a 50 basis point rate cut by the Fed in mid-September, with an additional 76% expecting a 25 basis point cut.
The market also anticipates three rounds of rate cuts by the Fed in September, November, and December, with expectations of lowering rates to 3.75%-4.00% by the end of the year, implying a possibility of a cumulative 150 basis point rate cut within the year.
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Analysts believe that the Fed will do everything in its power to ensure that the establishment candidates in the United States are not distracted by trivial matters such as market collapses before November 5th.
It may also orchestrate an epic dollar feast before November, potentially driving up asset prices in Wall Street and other global markets that are synchronized with rate cuts or have already entered a rate-cutting cycle.
This implies that, contrary to this trend, the Japanese market, which is entering a rate-hiking cycle, may face the uncertainty of being rocked by storms, with a significant amount of capital potentially withdrawing from the Japanese market and turning towards markets with looser monetary policies.
This seems even more certain against the backdrop of turmoil within the Japanese cabinet.
A new development is that the latest data released on August 23rd shows that due to the Japanese government's temporary halt of subsidies for electricity and natural gas, the country's inflation rate has increased.
With the rise in energy costs such as electricity, Japan's core inflation rate accelerated for the third consecutive month in July, still exceeding the central bank's 2% target.
The core consumer price index, excluding fresh food, rose by 2.7% year-on-year, higher than the 2.6% in June.
Adding to the woes, as of August 25th, in response to Japan's earlier warning of a potential major earthquake, Japanese consumers continue to stockpile daily necessities and food.
In addition to water and emergency supplies, rice is also being snapped up.
So far, people across Japan have noticed a shortage of rice supplies in supermarkets, with shelves largely empty and some even posting notices of rice purchase restrictions.
This phenomenon is also known as the ongoing "Reiwa Rice Riots."
The Japanese Ministry of Internal Affairs and Communications' July national consumer price index shows that rice prices rose by 17.2% year-on-year, the largest increase in 20 years, with main rice prices reaching an 11-year high.
This seems to explain why Bank of Japan Governor Haruhiko Kuroda reiterated on August 23rd that as long as the economy continues to move towards the 2% stable inflation target, the Bank of Japan will continue to pursue policy normalization.
That is, after the Bank of Japan's sudden interest rate hike of 0.25% at the end of July, there is still a possibility of further rate hikes this year, and the Bank of Japan is completely bidding farewell to the monetary easing, zero interest rates, and even negative interest rate environment that has lasted for a decade.
The Bank of Japan is also going against the Fed's interest rate cut channel and the global general monetary easing strategy, and even in the eyes of most Japanese investors, the Bank of Japan and the yen are taking a big risk.
At the same time, the yen is facing the risk of strengthening, and the yen asset prices may also continue to plummet.
On August 25th, the exchange rate of 1 US dollar to yen was 144, and after reaching a low point of 162 yen in July, the yen has risen by about 11% in the past month.
Mitsubishi Securities and Nomura, among other institutions, believe that the US dollar exchange rate with the yen may reach an interval of around 120 next year, and the yen may still have more than 15% room for appreciation, which will be a huge blow to yen asset prices.
Based on this, some Japanese media and institutions believe that under this expectation, it will promote Japanese capital to flow into the US and Chinese bond markets.
Signs indicate that as the Fed's willingness to cut interest rates in September becomes stronger, and as the People's Bank of China cuts interest rates, Japanese investors are increasing their holdings of US and Chinese bonds.
Data released by the Japanese Ministry of Finance on August 22nd shows that as of the week of August 17th, Japanese investors net purchased 1.85 trillion yen (about 12.8 billion US dollars) of overseas long-term debt securities, the highest level since mid-May.
This is the third consecutive week of net purchases, driven by the rising expectations of the Fed's interest rate cuts, which will push up US bond prices.
Data shows that from January to June this year, Japanese investors net purchased US bonds worth 7.41 trillion yen, the fourth largest semi-annual data since 2014.
It is worth noting that in the first half of 2022, Japanese investors sold foreign bonds to reduce losses caused by the rise in global interest rates.
In these six months, they net sold a record high value of 12 trillion yen of US bonds.
And after the Fed's expected tightening cycle this year, many people have started to rebuild positions.
Nomura Securities Senior Interest Rate Strategist Naokazu Koshimizu said that banks raising dollars in the repurchase market bought US mortgage-backed securities and other assets in the first half of 2024.
For example, although life insurance companies (traditionally one of the largest Japanese buyers of US bonds) are still cautious about currency hedging costs, many other buyers are enthusiastic.
Manulife Investment Management Director Akihisa Abeta said: "Pension funds and other institutional investors are still interested in buying US bonds, mainly investment-grade corporate bonds."
It is worth noting that data from the Japanese Ministry of Finance also shows that Japanese investors' investment in Chinese long-term bonds is also strong.
In the first half of this year, Japanese investors net purchased Chinese bond assets worth 667.6 billion yen.
This is the highest level since 2014.
It also indicates that a large amount of Japanese capital is accelerating into China.
At the same time, Japanese investors net sold 1.96 trillion yen of European bonds from January to June, which is the second half-year in a row for selling European bonds.
This includes 898.9 billion yen of German bonds and 986.2 billion yen of Dutch bonds, respectively the highest six-month figures since 2019 and 2014.
The reason for selling European bonds is concern that the far-right winning in the June European Parliament elections may lead to fiscal problems in major member states of the eurozone.
The yield spread between German 10-year government bonds and French bonds (a risk perception indicator) recently hit a 17-year high.
At the same time, it also serves as a warning to the embattled Japanese cabinet and the country's economy.
President of All Nippon Asset Management Tatsuki Nagano said: "Given the risk of further appreciation of the yen, it is difficult to buy bonds without currency hedging.
More investors may use partial hedging when buying foreign bonds."
The trend of the yen is expected to affect Japan's investment in foreign bonds in the second half of the year.
However, some analysts believe that if the yield of yen-denominated bonds rises high enough, Japanese investors may also turn their focus back to domestic bonds.
In other words, Japanese investors' arbitrage transactions of borrowing low and selling high, and buying low and selling high globally may continue.
In May and July this year, the yield of 10-year Japanese government bonds rose to the highest level of 1.1% in 13 years.
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