Australian bonds face squeeze as Japan's cash returns home

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Two years of Japanese selling can deepen in Aussie bond mkt

Large proportion of Japanese ownership leaves Australia exposed

BOJ key to Japanese money flows

By Stella Qiu

SYDNEY, Feb 6 (Reuters) -Japanese investors are extending their march out of Australia's $600 billion bond market amid risks that it becomes a rush later this year at any further hints of a policy tweak from the Bank of Japan (BOJ).

Estimates vary, but analysts believe Japanese investors own between 7% to 15% of Australia's sovereign and semi-sovereign bonds - a higher proportion than their roughly 4.7% ownership of the U.S. Treasury market - leaving Australia uniquely exposed.

Bond dealers say the situation has attracted short-sellers, as speculation swirls that Japan will ultimately start to exit ultra-easy monetary policy and let the market set bond yields, accelerating the repatriation of Japanese money.

The positioning also leaves other investors and the price of borrowing for Australia's government vulnerable, as at least 15 years of reliable Japanese inflows could reverse as yields in Japan start to become more attractive.

Japanese investors that have looked at higher-yielding markets like Australia will have an alternative if that happens, said Andrew Lilley, chief interest rates strategist at investment bank Barrenjoey in Sydney.

"People have concluded Australian government bonds will underperform, because Japan is seen as more of an outsized buyer of Australian bonds than they are of euro area or U.S. or UK bonds," he said. "In fact, many people have short Aussie bond positions."

A swinging yen and the increasing cost of currency hedging for investments abroad have contributed to Japanese selling so far by eroding the yield benefit of international holdings.

BOJ data showed net Japanese selling of Australian debt of 214 billion yen ($1.7 billion) from January to November last year - the most recent figure available - on top of 1.5 trillion yen of net selling in 2021.

Since then, the Japanese central bank stunned markets with a surprise widening of its target band for 10-year yields in December, and any further shift to its policy of holding down borrowing costs would be an epochal move after decades of loose settings.

December and January data is not yet available, but there are signs demand for Australian bonds is ebbing.

Japanese investors took just 2.3% of the last syndicated bond sale of A$14 billion ($10 billion) 2034 paper, compared to 32% for the rest of Asia, data from the Australian Office of Financial Management showed.

"The risk from here is that limited Japan selling in 2022 of Australian fixed income could pave the way for a more aggressive selldown in 2023 should the BOJ policy shift more hawkish," said Prashant Newnaha, a senior rates strategist at TD Securities.


Most of the ownership, and most of the selling so far, has been at longer tenors, BOJ data shows. Giulia Specchia, a rates strategist at UBS, expects that part of the yield curve to be the most vulnerable to further BOJ tightening.

To be sure, the sort of Japanese investor holding long-dated Australian bonds - pension funds, life insurers and other big institutions - are conservative, slow-moving and unlikely to cut and run from Australian in an unseemly rush.

Even still, a BOJ considering policy changes or allowing Japanese yields to rise presents such a challenge to so many bedrock assumptions for Japanese money managers that allocation changes will follow eventually.

"If there are further changes to the BOJ policy, that will further impede Japanese demand for offshore assets," said ANZ’s senior rates strategist Jack Chambers.

That is more likely to extend selling pressure than lead to a sudden rush for the exits, he said.

"I think there will be a steady stream, as we have already been seeing."

Additional reporting by Gaurav Dogra in Bengaluru and Tom Westbrook in Singapore; Writing by Tom Westbrook; Editing by Jamie Freed


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